Public Disclosure Authorized
Report No. 32857-LB
Report No. 32857-LB
Lebanon Public Expenditure Reform Priorities For Fiscal Adjustment, Growth and Poverty Alleviation
Public Disclosure Authorized
March 23, 2005 Social and Economic Development Group Middle East and North Africa Region
Public Disclosure Authorized
Lebanon Public Expenditure Reform Priorities for Fiscal Adjustment, Growth and Poverty Alleviation
Public Disclosure Authorized
FOR OFFICIAL USE ONLY
Document of the World Bank
This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.
Acknowledgements
M a n y Bank staff contributed to this report: Chadi B o u Habib (fiscal stance, debt mslnagement), Rachid Bouhamidi (utilities), Monali Chowdhurie-Aziz (utilities), Pierre Demangel (budget processes), Skbastien Dessus (macroeconomics), Haneen Sayed (social expenditures), Thirumalai Srinivasan (social expenditures), Giulio de Tommaso (public sector employment, budget processes), and Zafiris Tzannatos (social expenditures). The team received comments, data and suggestions from Richard Allen, Philip Anderson, Regina Bendokat, Robert Beschel, Robert B o u Jaoude, Jad Chaaban, Samir El Daher, Olivier Godron, Anca Mataoanu, Albert0 Musalem, Montserrat Pallares-Miralles, Bassam Ramadan, Setareh Razmarah Omar Razzaz, David Robalino, Radwan Shaban, Carlos Silva-Jauregui, Tjaarda Storm Van Leeuwen, Andrew Stone, Vinaya Swarup and Paolo Zacchia. Comments were also received from Suzanne Alavi, Stephan Danninger, Edward Gardner, Herve Jolly, Eric le Borgne and Joannes Mongardini, all from IMF. Peer reviewers were Roland Clarke and Santiago Herrera, from the Bank, and Charbel Nahas, coordinator o f Lebanon’s policy reform committee. M a y Ibrahim edited the report and Rola Mourdaa provided valuable research assistance. The report was prepared under the guidance o f Mustapha Nabli, Joseph Saba and Dipak Dasgupta. Nadir Mohammed, initially task manager, wrote the concept note. SCbastien Dessus led the exercise to its completion. Various Government officials, advisors, elected officials, academics and researchers, private sector representatives and representatives o f the international community provided guidance to the report. The team would like to express gratitude toward the esteemed contributors to the report including the lamented late Basil Fuleihan (Parliamentary Committee o n Economic Affairs, Trade, Industry, and Planning), Fouad Siniora, Elias Saba, Demianos Quattar, Alain Bifani, Jihad Azour, Hala Salem, Rola Rizk, Kawthar Dara, Nelly, Habib Elias Charbel, Rabah Marini, and Nabil Yamout (Ministry o f Finance), Mazen Hanna (Prime Minister’s Office), Samir Azar (Parliamentary Financial and Budget Committee), Naamat Kanaan and Adib Naameh (Ministry o f Social Affairs), Fadi M a k k i and Ghazi Jaafar (Ministry o f Economy and Trade), Waleed Ammar, Youssef Abou Daher and Fouad Alameh (Ministry o f Public Health), Khalid Arzouni and Adnan Hamoud (Ministry o f Environment), Maurice Kaii, Georges Zamar and Mona Kabkab (ElkctncitC du Liban), Mohammed Baroud (Ministry o f Water and Energy), Joseph Nossier (Beirut and Mount Lebanon Water Authority), Marwan Iskandar (M.I. Associates), Kamal Hamdan (Consultation and Research Institute), Wafaa Shareffedine (Council for Development and Reconstruction), Ramzi Naaman (Community Development Project) and Haitham Omar (Social Fund), Christian de Clerq (United Nations Development Programme) and Randa AboElhassan (United Nations Industrial Development Organization),
Abbreviations and Acronyms
ABL APEC BdL BOT CAS CAS CDR CFAA CIB CIS CPI CPIA CPPR CSB DBOT DOT DPT EdL EDP EMU ENA EOSI ERF EU FAD GATFA GDDS GDP GIT GFS GFMIS GNI GoL GST HMIS HR IDAL IMF ICT IT Kwh LBP LIBOR MENA
Lebanese Banking Association Asia Pacific Economic Cooperation Banque du Liban (Central Bank o f Lebanon) Build Operate Transfer Country Assistance Strategy (World Bank Document) Central Administration o f Statistics Council for Development and Reconstruction Country Financial Accountability Assessment Central Inspection Board Community o f Independent States Consumer Price Index Country Policy and Institutional Assessment Country Portfolio Performance Review C i v i l Service Bureau Design Build Operate Transfer Department o f Tenders Diphtheria, Pertussis and Tetanus ElCctricitC du Liban (Lebanon Electricity) Education Development Project European Monetary Union Ecole Nationale d’ Administration End-of-Service Lndemnity Economic Research Forum European Union Fiscal Affairs Department (IMF) Greater Arab Trade Free Area General Data Dissemination System Gross Domestic Product Generalized Income Tax Government Financial Statistics Government Financial Management Information System Gross National Income Government o f Lebanon General Sales Tax Health Management Information System Human Resources Investment Development Authority o f Lebanon International Monetary Fund Information and Communication Technology Information Technology Kilowatt per hour Lebanese Pounds London Inter Bank Offering Rate Middle East and North Africa
MNSED MoE MoET MoF MoPH MoSA MTEF MW NGO NHA NSSF OECD OMSAR PER PM PPP SDC SME SMP SOE TB TFP TIMSS UK UN UNDP UNIDO
us
VAT WDI WHO WTO
Middle East and North Africa Social and Economic Development (Group) Ministry o f Education Ministry o f Economy and Trade Ministry o f Finance Ministryo f Public Health Ministry o f Social Affairs Medium-Term Expenditure Framework Mega Watt Non-Governmental Organization National Health Accounts National Social Security Fund Organization for Economic Co-operation and Development Office o f the Minister o f State for Administrative Reforms Public Expenditure Review Prime Minister Purchasing Power Parity Social Development Center Small and Medium Enterprises Statistical Master Plan State-Owned Enterprises Treasury Bills Total Factor Productivity Trends in International Mathematics and Science Study United Kingdom United Nations United Nations Development Programme United Nations Industrial Development Organization United States Value Added Tax World Development Indicators World Health Organization World Trade Organization
Table o f Contents
Executive Summary ........................................................................................................................ 1 Introduction - Public Expenditure Review Scope and Objectives ............................................... 11 Chapter I. Fiscal Adjustment for Growth ..................................................................................... 13 The Immediate Challenge: Fiscal Adjustment for Growth and Poverty Alleviation .............. 13 Cutting Primary Expenditures and Privatizing Public Assets ................................................. 17 The Impact o f Expenditure Containment on Growth: Keynesian versus Credibility effects. 20 Policy Options ......................................................................................................................... 23 Chapter I1. Containing Primary Spending: What Can Be Done? ................................................. 27 Wages ...................................................................................................................................... 27 Pensions .................................................................................................................................. 30 Transfers to Extra-Budgetary Entities .................................................................................... 31 Other Current Expenditures .................................................................................................... 34 Capital Expenditures ............................................................................................................... 35 Possible Medium Term Expenditure Outlooks ....................................................................... 37 Chapter 111. Raising the Efficiency o f Social Spending and Strengthening Safety Nets .............. 41 Social Sector Expenditure and Outcomes ............................................................................... 42 Social Sector Efficiency .......................................................................................................... 46 51 Planning for Long Term Social Development ........................................................................ The need to Strengthen Lebanon’s Safety Nets ...................................................................... 53 57 Chapter IV. Building Capacity for Better Provision o f Public Goods .......................................... . . The Current Situation .............................................................................................................. 57 The Reform Agenda ................................................................................................................ 62 Public Administration ............................................................................................................. 62 . . Public Financial Management................................................................................................. 64 . . Civil Service............................................................................................................................ 67 Corruption ............................................................................................................................... 68 Annex 1. Developments in Public Finance, 1991-2004 ............................................................... 70 Overview ................................................................................................................................. 70 Quality o f Fiscal Data ............................................................................................................. 70 Public Expenditure Structure and Evolution........................................................................... 71 Public Revenue Structure and Evolution ................................................................................ 72 Annex 2 . Government Institutions in various selected countries ................................................. 78
List of Figures
Figure 1. Economic Performance in Fiscal Crisis Countries ........................................................ 17 Figure 2. Performance in Science (8‘h Grade) By GDP Per Capita .............................................. 45 Figure 3 . Hospital Occupancy Rates............................................................................................. 47 Figure 4 . Type o f Health Expenditure by Source in 2000 ............................................................ 48 Figure 5 . Regional Imbalances in Satisfaction with Basic Needs and Adult Illiteracy ................ 48 Figure 6 . Governance Indicators: Comparison with Regional Average ....................................... 58 Figure 7 . Governance Indicators: Evolution over Time ............................................................... 59
List of Tables
Table 1. Macro-Economic and Fiscal Developments. 1997-2004 ................................................ 15 16 Table 2. Duration. Output and Fiscal Losses o f Financial Crises. 1994.2003 ............................. Table 3 . Economic Classification o f Public Primary Spending .................................................... 27 39 Table 4 . Prospective Public Expenditure Outlooks (as a percentage o f GDP) ............................. Table 5 . Government’s Arrears as o f end-2004 (LBP Billion) ..................................................... 40 Table 6 . Public and Private Social Expenditures (LBP Billion and as percentage o f GDP) ........ 43 Table 7 . Health outcomes and per capita spending. selected MENA Countries .......................... 44 44 Table 8 . Education indicators and GNI per capita. selected MENA Countries............................ Table 9 . Price levels in comparator countries in 2003 .................................................................. 46 Table 10. Pupil t o Teacher Ratios (2002) ..................................................................................... 47 49 Table 11. Beneficiaries allocation among Mohafaza’t (Governorates) ........................................ Table 12. Lebanon Fiscal Stance. 1991-2004 ............................................................................... 74 Table 13. Economic Classification o f Expenditures 1991-2004 .................................................. 75 Table 14. Functional Classification o f Expenditures 1991-2004 .................................................. 76 Table 15. Government Revenue 1991-2004 ................................................................................. 77 List o f Boxes
B o x 1. Improving Debt Management..................................................................... 25 B o x 2 . Information and Statistical Issues., .............................................................. -55 B o x 3 . Institutional Reform Worldwide ................................................................... 69
Executive Summary The Economic and Political Setting I t i s now time for Lebanon to decisively move from declining reconstruction and perilously managing its public finances to securing new sources o f revitalization and development. Lebanon has achieved considerable success during the past fifteen years in reconstructing i t s war-damaged economy. The country has also achieved a newfound sense o f confidence and optimism from i t s recent political renewal. Yet, i t s economic conditions remain very fragile. This i s a critical time for all decision-makers, political parties and the Government to re-examine the hndamental economic constraints to a better outlook for the country’s citizens. New sources o f growth, a revitalized private sector, and greater opportunities for jobs and employment have to be established. N e w ways o f addressing social safety nets and targeting social expenditures to the country’s less well-off must be devised. And a new social contract between the country’s citizens and the State has to be designed to redefine the core functions o f the state away from providing rents and employment for narrow political interests to an efficient and lean national government providing critical public services for all citizens. An encouraging international climate exists for supporting Lebanon’s progress in these directions, provided a national consensus o n key reforms of i t s economic policies can be reached in the months and years ahead. A key element of removing the binding economic constraints to Lebanon’s future growth and social progress lies fundamentally in dealing with the country’s huge public debt, which needs to be contained and reversed by deep-seated fiscal adjustment. That fiscal adjustment will require a number o f difficult and painful choices: to raise new taxes, contain overall public spending, cut spending in unproductive areas, reduce entitlements for relatively privileged groups, privatize public enterprises, and restructure public debt. None o f these can happen without a strong buy-in and vision o f a different future from all cross-sections o f society, especially as it relates to restructuring public spending priorities. The recommendations o f this review o f public expenditures in Lebanon are thus guided by the twin objectives o f identifying a set o f public expenditure reforms that could simultaneously contain public spending to support fiscal adjustment and structurally improve Lebanon’s growth potential and social protection. Both are critical if the Government wishes to regain the confidence o f i t s citizens and the credibility o f i t s policies with creditors. Securing the Objectives: Fiscal Adjustment, Growth and Poverty Alleviation With the world’s highest debt to GDP ratio, any sustainable growth and poverty alleviation strategy for Lebanon has to consider the avoidance of financial turbulence as its main immediate element. Lebanon’s public debt ratio o f 165 percent o f GDP by year-end 2004 - and closer to 200 percent if account is made for the Government’s arrears and Central Bank losses on a consolidated public sector basis - i s clearly unsustainable in the face o f the slow growth in the economy and the high interest rates on its debt. The deterioration o f the financial situation in Lebanon following the assassination o f former P M Hariri (February 14, 2005), coupled with the rising global interests and deceleration o f economic activity in the MENA region have further
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increased Lebanon’s vulnerability to a full-fledged confidence crisis. Past experience around the world systematically demonstrates that private markets cannot indefinitely accommodate rising public debt ratios. Even the most faithful investors can eventually lose confidence in the Government’s capacity to service i t s debt, and a major crisis can then ensue, with potentially devastating effects on the country’s economic and social fabric. Protecting Lebanon from a crisis-led deep recession i s a high priority for an effective growth and poverty alleviation strategy. Maintaining financial stability alone, however, will not be sufficient to achieve the country’s economic and social objectives, as the country’s current fiscal imbalances already severely affect economic activity and social conditions. High public deficits and rising debt have themselves contributed to the sharp deceleration o f real GDP growth since the mid-1990sY following the initial post-war boom o f reconstruction. The channels for these strong negative effects are persistent government borrowing requirements that have raised real interest rates to very high levels, and rising macroeconomic risks o f financial crisis (associated with higher debt) that have crowded out and reduced private investment (and in turn private capital accumulation and productivity growth). In recent years, the real economy benefited from an exceptional combination o f favorable external shocks, but the long term growth potential o f the Lebanese economy remains constrained, in the face o f very limited productive investments and deepseated structural barriers to private sector activity. With slow growth, social conditions and inequalities are worsening, and Lebanon’s human and natural capital stocks are eroding. Unemployment is growing, prompting young generations o f qualified workers to emigrate in large numbers. And insufficient attention and investment to protect the environment have entailed irreversible degradation o f land and water resources. In this context, Lebanon has no alternative but to seize all opportunities to immediately reduce the deficits and debt levels to considerably lower levels, with the objective o f putting the country’s debt to GDP ratio o n a steadily declining slope to ultimately regain fiscal solvency. Regaining the credibility and confidence of creditors and citizens through careful containment of the Government’s primary spending i s of utmost necessity. Along with tax increases, privatization and debt restructuring, containment o f non-debt public expenditure has to play a key role in restoring fiscal sustainability, both from accounting and signaling perspectives. Any saving on public spending will contribute to a higher primary surplus, hence reinforcing the likelihood o f a successful fiscal adjustment. And World Bank staff calculations suggest that sizeable savings could be made on unproductive expenditures without compromising the provision o f public goods and services. But perhaps more importantly, cutting back on unproductive and inefficient public expenditures will send a strong and credible signal o f Lebanon’s commitment to address, at i t s roots, its fiscal imbalances and improve i t s overall use o f public funds. This i s an indispensable condition to protect growth during the adjustment by convincing potential investors and citizens that their situation will improve in the medium run. International experience underlines the critical role o f credibility in ensuring successful fiscal adjustments episodes, where the short-term negative impact on output o f public expenditure cuts can turn rapidly positive in anticipation o f a better economic fbture, and greater investment opportunities. Financial markets will respond to improved credibility by lowered interest rates; investors will respond by increased capital inflows and financing investment, ensuring faster growth; and citizens will respond by a greater willingness to carry the burden o f adjustment if i t
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i s distributed fairly. In Lebanon, the immediate negative impact o f fiscal adjustment on growth should not be underestimated, given the size o f the debt stock and i t s related financing needs, the high degree o f capital mobility and the significant barriers to investment activities in many sectors. At the same time, and unlike many countries, Lebanon can also benefit from a very large investment potential, given the country’s exceptional ability to attract foreign funds, and recent episodes - Paris I1 for instance - that have illustrated the potentially huge response o f financial markets to perceived greater fiscal credibility. The quality o f expenditure containment i s thus a key dimension o f any adjustment plan. Beyond the pressing objective of gaining fiscal space, public expenditure reform should also be designed with the aim o f improving the investment climate and reinforcing social protection. Public primary expenditures are l o w in Lebanon (at 21 percent o f GDP approximately), and cannot support alone the burden o f adjustment. Debt sustainability analysis conducted by the World Bank suggests that the primary surplus would need to exceed 10 percent o f GDP (up from 1 to 2 percent in 2004, including arrears) to simply stabilize the debt to GDP ratio. Depending o n the growth in economic activity, 2 to 4 percentage points o f GDP could be saved through bold expenditure containment over a five-year period. Clearly, large tax increases would hence need to accompany and even probably precede these measures, given the difficulty to rationalize expenditures in a very short period, which could prove to be politically challenging in the Lebanese context. Other possible ingredients to curb the debt - namely debt restructuring, privatization and external assistance, are also far from being easily achievable. And even if all these ingredients could be mobilized together rapidly, the debt to GDP ratio would s t i l l remain largely above 100 percent in the foreseeable future, leaving Lebanon vulnerable to financial disruption. At any time a confidence shock could eliminate the long and painful efforts undertaken to adjust fiscally. Hence, expenditure containment for i t s own sake will look irrelevant in the face of i t s high political and social costs, and additional objectives are required to justify it. Improving Lebanon’s growth potential through better public service delivery and investment climate and reinforcing social protection are the natural candidates. Indeed, several important structural obstacles to growth and social protection are directly related to poor public expenditure management (unproductive public administration, corruption, ineffective resource allocation, poor management of public enterprises). In other words, large spending in some sectors i s the symptom o f inefficiencies and weak governance, and expenditure reform, if properly designed, can prove to be a very powerful means to foster growth and alleviate poverty, beyond i t s impact on protecting the economy from financial crisis. Success in rationalizing public expenditures i s contingent on citizens’ acceptance of a new social contract, which would redefine the nature o f their relationship with the State of Lebanon. However important might be the objective o f expenditure containment, spending cuts will immediately affect civil servants, current beneficiaries o f public services and largesse, and overall economic activity through a contraction o f aggregate demand. Unless citizens can rapidly perceive an improvement in the nature o f their relationship with the State and feel that the burden of adjustment i s equally shared across the population, the indispensable political support for a deep reform agenda will fade away rapidly. The overall design o f strategy should therefore attach considerable importance to i t s political feasibility. This will mean that social protection should be reinforced in the immediate phase o f spending declines, to protect the most vulnerable segments of society against i t s immediate negative effects. Privatization programs should
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consider and deal carefully with the fate o f current state-owned enterprises’ employees and also seek a good compromise between economic, fiscal and social impacts, by setting, for example, l o w tariffs and connection fees for basic privatized services. Finally, all economic constituencies should contribute to the adjustment effort, for instance through the implementation o f a generalized income tax imposed on all sources o f incomes. In the longer term, institutional reform should aim to shift the structure o f current spending patterns from objectives o f narrow political redistribution to that o f efficient public goods provision to all sections o f society. Key areas of expenditure reform comprise reducing the civil service and reforming pension schemes, changing the management and control over large loss-making public autonomous agencies and enterprises such as the EDL, improved budget processes and execution, and expanded social protection. Some o f the policy options envisaged in this review can be implemented rapidly, irrespective o f the fundamental choices that Lebanon should make regarding the future role and responsibilities o f the State. Pension reforms and power sector reforms are very high on the agenda and could save some 2-4 percent o f annual GDP in public spending. Other related actions will require immediate diagnostics to expand the options. They include a civil service census and a review o f public employees’ functions and remunerations; a review o f social spending coverage and targeting efficiency; the auditing o f all extra-budgetary funds and government arrears; and the complete re-examination o f existing public investment commitments. I t also concerns the institutional capacity and legal means required to effectively implement any strategic reform, notably through: the restoration o f the C i v i l Service Council’s executive powers and the Court o f Accounts’ independence and capacities; the revision o f procurement and public accounting laws; the reinforcement o f Lebanon’s statistical and planning capacities; the imposition o f hard-budget ceilings to ministries during budget preparation; the consolidation o f current and capital budgets; the immediate stoppage o f arrears’ build-ups practice and the limiting carry-forward o f expenditures. Turning to the medium-term,, choices needed to be made regarding the role o f the State o f Lebanon, and to adjust strategic policy design in the following areas: the structure o f public pension schemes and wage and benefits, social protection and safety nets, provision o f public infrastructure and regional development, performance-based budgeting, and roles and responsibilities o f extra-budgetary funds in the provision o f public goods and services. The menu is large and urgent and described further below by main subject areas. Reducing the Size of the Public Labor Force for Better Service Delivery Lebanon’s overall public wage bill i s low by international standards, but opportunities exist for considerable savings through future retirements that should be used to build a competent civil service capacity. Lebanon’s public labor force i s numerous, underpaid and unmotivated, subject to corruption and unresponsive to people’s needs, which i s a major element o f citizens’ dissatisfaction with the State. At the same time, many civil servant positions are left vacant. On the whole, it i s safe to say that the Government in Lebanon i s severely overstaffed for the functions it currently performs. A better paid, more competent, smaller public force should be the objective. In the next ten years, up to 45 percent o f the current public labor force (some 220,000 workers, including civil servants, contractual workers and military) will retire. The Government should reap this golden opportunity to reduce i t s labor force through attrition, as it presents less technical and political difficulties than retrenchment. Funds saved o n the current
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wage bill should be used to increase civil servants’ salaries, regularly train staff and cover reallocation costs o f some staff to new tasks. In the short run, this will necessitate (i) a review o f a civil service census (iii) a employment needs and adequacy to Government’s objectives, (ii) termination o f the current hiring and wage freeze in place since 1997, and (iv) the full restoration of the C i v i l Service Council’s executive powers. I t will also critically necessitate a reform o f the current civil and military pension schemes, whose deficits are fully covered by the budget, to contain their fiscal cost in the face o f a growing number o f retirees. Finally, with a view to rebuild capacity within the administration to ensure continuity and accountability, the reliance o n parallel staffing structures should also be reduced as much as possible. A rapid and effective rightsizing o f the public labor force i s conditioned on the need for reform of civil and military pension schemes. Government employees (and more broadly the populations’) acceptance o f a large retirement plan i s most likely contingent o n the development of effective safety nets and sustainable pensions schemes. Public employment has progressively become in the post-war period an expanded social safety net, which needs to be replaced by other more effective ones, to get the support o f the population and satisfy citizens. Today though, formal safety nets are inadequate and weak (see below), and public (civil and military) pension schemes are unsustainable financially - hence unable to absorb large number o f new retirees without seriously compromising the fiscal adjustment objectives evoked above. Various options of reform to restore the public pension schemes’ financial sustainability are nevertheless feasible, and could yield significant additional fiscal and developmental benefits. World Bank staff calculations indeed suggest that a simultaneous reform o f public and end-of-service indemnity schemes could permit the rapid integration o f the various public and private pension schemes, at l o w fiscal costs. This would eliminate the implicit Government’s pension debt over the long run (currently above 50 percent o f GDP), reduce inequalities between public and private workers (in terms o f coverage) and facilitate labor mobility between public and private sectors. Public labor force non-wage benefits should eventually be replaced with higher wages, Obviously, the reform o f public pension schemes would eventually necessitate reducing the benefits accruing to current and new retirees, as considered much too munificent (Lebanon’s military and civil schemes are respectively ranked first and second most generous schemes in the MENA region) in the face o f Lebanon’s financing capacities, demographic structure and inequalities in access to pension coverage. O n the same token, benefits (family allowances, education, and health) to public sector employees should be reviewed’ in light o f actual social needs, and probably replaced with more direct and effective means o f channeling assistance to the poor, This decline in non-wage benefits would typically be offset with higher wages in the public sector, N o t only would this permit reinforcing social protection policies effectiveness, but would also establish a better link between individual performance and remuneration in the public sector.
Data gathered with the recently completed household budget survey should permit t o review the effectiveness (targeting, coverage) o f current social policies.
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Revisiting the Role of Extra-BudgetaryEntities Lebanon’s budget i s burdened with large transfers to extra-budgetary entities, whose activities need to be audited and consolidated into the budget. Public autonomous agencies, funds and enterprises operating outside o f Parliament’s control (hence not concerned by the budget cycle) represented 19 percent o f total public spending in 2004. While not part o f core activities o f the Government, their activities have important fiscal implications. Very often, the absence o f any binding budget constraint (governance problems, lack o f accountability and accounts) prompts these entities to run large arrears and losses, which are eventually covered by the Government in the form o f grants or loans. In 2004, 9 percent o f non-debt public expenditures went to cover public electricity and water companies operational losses and debt repayments. Subsidies can obviously be justified (in the case o f positive externalities for instance), but have to be explicit to remain under Parliament control, facilitate medium term expenditure planning and reinforce extra-budgetary funds accountability. As posing a significant risk o f seeing public funds not being spent for the purposes for which they have been appropriated, it i s hence important that (i) the Government rapidly have at one’s disposal a set o f that audited consolidated financial statements that cover all non-budgetary entities; and (ii) public autonomous agencies and funds budgets be fully consolidated into the budget o f the Government and their accounting, reporting, oversight and governance structures be significantly improved. The role of these extra-budgetary entities, as providers of public goods, should be reassessed and the decision to maintain them in the public domain made accordingly. Over the last years, the Government has legally or technically paved the way for the privatization o f some o f these agencies and enterprises, but two elements, inter alia, have probably prevented i t s realization so far. First, the role and responsibilities o f entities foreseen to be privatized have yet to be spelled out, in order to forge consensus on their destiny. Some o f them are indeed playing important roles in terms o f providing implicit subsidies or additional public revenue in the form of monopolistic rents. Actually, some public enterprises are generating net revenue for the Government, but maybe at the expense o f greater competition and growth. A greater participation o f the private sector in these enterprisedagencies - up to privatization, would require an ex-ante distinction between “normal” private commercial operations and the set o f instruments (tax and subsidies, regulation o f tariffs and standards, etc.) that would remain in the hands of the Government to regulate markets and provide public goods. Second, some o f these entities need major overhaul (including audited accounts, investments, debt relief, etc.), such as the electricity company, and a credible regulatory framework first to eventually attract private investors’ interest. Privatization should accompany fiscal adjustment, with a view to primarily promote growth. For heavily indebted countries like Lebanon, i t i s critical that privatization proceeds b e used to reduce the debt stock. But when privatization proceeds are used to retire debt, the Government should ensure that this i s done as part o f a package o f measures that are sustainable fkom the financial point o f view in bringing the stock o f debt down. Otherwise, the reduction in interest payments will be short lived, and a perverse debt dynamic will resume as soon as privatization proceeds run out. The potential privatization proceeds will therefore be wasted if they are not used in the context o f an overall fiscal consolidation agenda. Furthermore,
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privatization should aim in priority at promoting cost effective private service delivery. Indeed, the incentive to increase the sale price (through granting monopolistic positions to new private incumbents or imposing l o w requests in terms o f future capital investment outlays) might be at the expense o f future improvement in the service. As tempting as i t i s to measure the efficacy o f privatization in terms o f sales price, i t i s the long-term impact on quality and price o f service, and i t s contribution to spurring growth and economic development that i s most critical. Improving Current and Capital Expenditure Management Expenditure management can be improved to raise public spending efficiency. The economy and Government’s budget are not receiving the full benefits o f the public expenditures that are being made, as evidenced for instance in terms o f social and investment outcomes. Various elements are candidates to explain such shortcomings: outdated procurement policies, absence o f competition among suppliers o f goods and services purchased by the Government, lack o f planning and consolidation between current and capital expenditure, high fiduciary risks and corruption stemming from inappropriate control and audit framework. A revised draft public procurement l a w was prepared by the Government but was never passed by the Parliament. However, i f approved and implemented, such a law would not only greatly enhance the efficiency and transparency o f public procurement procedures, but i t would also accelerate disbursement o n donors’ projects. Recent steps taken by the Government to reform procurement practices regarding drugs and fuel purchasing illustrate the extent to which savings can be made by reinforcing competition among suppliers. The adoption o f a competition law would definitely help in generalizing these efforts to most government purchases. The revision o f the now outdated Public Accounting L a w and the development o f ex-post performance evaluation would mitigate corruption risks stemming from a lengthy, complex and non-transparent expenditure control process, w i t h a view to shift public practices from compliance to responsibility. Granting greater institutional independence to the Court o f Accounts vis-a-vis the Government and reinforcing i t s capacities would also be a crucial step in this direction. The adoption of a Medium Term Expenditure Framework (MTEF) would equally permit reducing wasted expenditures related to public investment decisions (i)not supported by sufficient counterpart budgets for operation and maintenance or (ii)simply stopped before completion in the face of poor macro-economic planning capacity at the Ministry o f Finance and absence o f accrual accounting. The role o f the Council for Development and Reconstruction (CDR), which manages on behalf o f the Government most o f the public investment projects, must be redefined to become an implementation agency o f Ministries, which would regain control o f their investment budget. And while an M T E F i s very important, for i t to be effective decision processes at the center o f Government have to be reformed. This includes early government decisions o n priorities and (in the current situation) policy decisions o n cost savings and service reductions which are communicated to ministries for their budget formulation process. I t implies the use o f hard budget ceilings for formulation o f the budgets and reforms o f the budget process within Ministries, to move away from simply summing up the cost o f inputs. I n the short run, the Government should immediately stop accumulating arrears. Although not yet audited and tentative (in the absence o f accrual accounting), the amount o f arrears accumulated as of end-2004 by the Government vis-a-vis the social security, government
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employees, suppliers and households i s seemingly sizeable, at approximately 10 percent o f GDP. Building-up arrears has various negative consequences: poorer fiscal transparency, higher tariffs for private services, weaker social safety nets, and greater difficulties to implement investment projects. In this respect, not accumulating new arrears i s a first immediate priority, which will nevertheless add about one percentage point o f GDP to primary spending (as measured on cash basis). Addressing the stock though, is a much more difficult undertaking, which could consist in transforming some o f the arrears into formal debt and the remainder being repaid progressively over years. Capital expenditure levels must be protected and investment plans entirely reviewed. Public investment spending i s not commensurate to outcomes. In spite o f large amounts disbursed since 1992, public investments are not yielding the benefits that should be expected, as evidenced by the number o f projects not yet completed, the poor quality o f the transportation system, the high costs o f power and communications utilities and the rapid deterioration o f the environment. Nevertheless, this unfortunate verdict does not justify further compressing capital expenditures, as Lebanon i s now reaching a point where i t s investment expenditures barely suffice to prevent the degradation o f i t s current stock o f infrastructures. In these conditions, the marginal cost o f further containing public investment in terms o f foregone growth most likely exceed the marginal gain stemming fkom i t s impact on public deficit. On the other hand, investment projects under preparation or already committed far exceed what Lebanon could realistically absorb in the next years without severely undermining i t s capacity to adjust fiscally. Priority should hence ultimately be given to the maintenance o f existing facilities, within an overall envelope consistent with the objective o f raising the primary surplus. This would notably require limiting carry-fonvards in the budget framework. A greater use o f donors’ funds should also be sought, for i t s impact on debt service and maturity profile, but also because i t would require moving on reforms that present other advantages: C D R reform, Procurement Law, Parliament ratification procedures, public investment planning, and lower reliance on arrears. Reinforcing Social Protection From a functional perspective, public social spending requires particular attention, as it i s a key element of a successful transition. Public social spending i s high in Lebanon (more than h a l f o f government primary expenditure including pensions), and i s a candidate for a deep review in a period o f necessary expenditure containment. Enhanced social protection i s also a critical ingredient to insure the political feasibility o f a drastic fiscal adjustment, as greater demand for public social services and equity considerations will emerge in the transition. Yet, seemingly high levels o f inefficiencies imply that the first order o f priority in the social sectors i s to raise the productivity o f public social sector expenditure rather than increase their resource envelope. A reduction in social spending via employment benefits to government employees is one such priority, savings being assigned to improve the supply o f public social service delivery to the needy. A second i s the more efficient regulation o f private provision in terms o f pricing and quality and coordination between the private and public sectors in the social arena, which ultimately requires from the Government the design o f a long-term strategic vision for i t s social policy: norms o f social services and protection, choice o f Government’s instruments for provision, financing and regulation o f social services.
8
I n the shorter run, there i s a pressing need to strengthen safety nets. One basic objective o f any social policy should be to protect human capital from irreversible losses occurring during crises (economic, political, natural disasters). Fiscal consolidation would typically aim at reducing the risk o f financial crisis, but probably not sufficiently in the next years to justify a continued absence o f protection for citizens against their potentially devastating impacts. The more so since the few safety nets existing in Lebanon would themselves be severely weakened by financial disruption. More generally, i t i s believed that Lebanon’s level and characteristics o f social protection are not adapted to the developmental needs o f a middle-income small open economy, and could actually be an impediment to growth. Dismissed as ineffective, expensive and even detrimental to growth, it i s now increasingly understood that assisting individuals, households and communities in dealing with diverse risks i s needed for sustained economic and social development. Hence there i s a need to reinforce existing safety nets and to plan for the mobilization o f new ones. If in place before a crisis occurs, properly designed social safety nets can serve as an automatic fiscal stabilizer and contribute to greater macroeconomic stability, and can bypass political pressures for panic allocation during the crisis, or for making spending permanent after the crisis i s over. In planning for safety nets, desirable principles to be adhered to include adequacy in terms o f coverage and benefit levels, greater targeting efficiency, and transparency to manage expectations that assistance i s temporary. Various options can currently be envisaged in Lebanon, from scaling up some o f the social programs to introducing conditional cash transfers. Most o f these options would nevertheless necessitate the availability o f reliable and periodic data on the incidence o f social spending to assess i t s efficiency and develop targeted and means-tested programs. This i s maybe the greatest priority for Lebanon in terms o f social policy today, As far as existing institutional safety nets are concerned, it could also be envisaged to reinforce the robustness o f end-of-service indemnity and guarantee o f deposits funds by (i) rapidly settling arrears accumulated with them and (ii)allowing them to diversify their investment portfolio for a better protection against various financial risks.
Forging a National Consensus on Public Expenditure Reforms I n the face of the urgency of the situation and difficulties ahead, Lebanon needs to forge consensus on fiscal reforms through a national political pact encompassing all key actors, Successful fiscal stabilization episodes in the world have all been achieved by strong and determined executive powers, benefiting from sufficient political support to sustain adjustment efforts over several years.
Political support will necessitate an equitable, credible, transparent and comprehensive adjustment plan, which can only be designed with the participation of all national stakeholders. A comprehensive public sector reform agenda should cover simultaneously four fronts: public administration, public financial management, civil service and corruption. In the Lebanese context, addressing the deficiencies in these four domains could go a long way in improving the credibility o f the institutions vis-&vis the population and the donors, and contribute positively to a successfbl fiscal adjustment. While the consensus i s widespread in terms o f identifying the public sector management woes which are afflicting Lebanon, finding a solution which can be translated into an appropriate action plan is much more difficult. The problem i s both the lack o f a deep debate on possible policy options and the difficulty to move out of a currently l o w non-cooperative political equilibrium. Each segment o f the society would
9
currently seek to have the other pay the price o f adjustment. It i s in effect a “prisoner’s dilemma” where all segments will gain from cooperating, and lose in the end i f each side sought to evade the cost. M o v i n g towards a higher cooperative equilibrium will require a comprehensive (in terms o f policy areas) and inclusive (in terms of participants) process to forge a national pact o n key reforms and action plan. Fragmented piecemeal efforts to address public sector reforms are unlikely to succeed without first re-defining the role o f the State and second secure the means and resources needed to fulfill it. Such a redefinition o f the Government’s core responsibilities requires input fi-om all stakeholders, to eventually place efficient and effective service delivery to citizens at the center o f all State’s actions.
10
Introduction - Public Expenditure Review Scope and Objectives
1. Public Expenditure Reviews (PERs) are conducted by the World Bank in all its client countries, typically every 4 to 5 years. PERs are part o f the Bank’s core diagnosis reports, whose content reflect analysis necessary for Bank country programs and strategy formulation. PERs examine processes o f resources allocation within and among sectors and assess the equity, efficiency and effectiveness o f these allocations in the context o f the macroeconomic framework and sector priorities. In Lebanon, the World Bank conducted a review o f public investment expenditures in 1995 and a review o f public social expenditures in 1999. I t never completed a comprehensive review o f public expenditure since the end o f the civil war in 1991. 2. Lebanon’s current priority - in the face o f high public deficits and unsustainable debt dynamics - i s to contain and rationalize public expenditures in every possible sector while improving the efficiency of social spending. The Government o f Lebanon (GoL) i s fully aware o f the need to address urgently i t s fiscal imbalances through expenditure containment, to eventually restore fiscal sustainability (see for instance the Government strategy presented at the donors’ Paris I1conference in November 2002* and the budget law 2003; the PER Concept Note and the World Bank’s Draft Country Assistance Strategy (CAS) discussed with the Government respectively in December 2003 and January 2005 emphasized this priority as well). The Government o f Lebanon also acknowledges the need to protect and improve the efficiency o f social expenditures, in order to protect the poorest segments o f the Lebanese population from adverse economic circumstances. Hence the primary focus o f this PER on cross-cutting issues regarding: (i)expenditure containment (public employment and wage policies, pensions, social transfers, subsidies, capital expenditures, debt management and privatization) and (ii) spending efficiency.
3. Nevertheless, the needed containment of primary public expenditures should be understood as a transition to restore fiscal sustainability and enhance growth prospects. The private provision o f services i s unusually high in Lebanon, but cannot replace that o f the Government in some key sectors, where the latter needs to reengage. There i s no optimal/unique prescription for either the size or design o f the public sector. Generally, beyond the core public activities, justifiable o n the grounds o f market failures (externalities, natural monopolies) or the existence o f pure public goods (non rival and n o n excludable, and the consequent inability to charge for these services), the design and implementation o f public expenditure priorities and the associated public-private m i x require detailed assessment and careful country-specific tailoring. In Lebanon, the absence o f well-defined public policy objectives - and the absence o f tools to assess the efficiency o f public expenditures in meeting these objectives, calls first for actions that would help Lebanon to better identify the current role o f i t s administration, and, accordingly, where i t should ideally concentrate i t s interventions. In turn, Lebanon will need to acquire the
* See Republic o f Lebanon (2002): “The budget for 2003 that has already been submitted t o the Parliament i s an austerity budget that envisages [an increase in revenue and] a further reduction in the ratio o f non-interest expenditures to GDP. Expenditures are being reduced across the board, except for social sectors so as to protect those most affected by the worsening o f the economic situation in recent years.” 11
means to achieve efficiently i t s policy objectives, which will require the modernization o f the civil service and budget processes. The second part o f the PER i s devoted to these longer-term issues. 4. This Public Expenditure Review aims at assisting Lebanon in its fiscal stabilization effort. The containment o f public expenditures could entail painfbl choices, which will first require an analysis to identify where spending pressw,es lie (contingent liabilities, social sectors), and how to address them. And ideally, elimination o f non productive spending should replace containment as the main instrument o f adjustment - not least to sustain growth in the face o f a withdrawal o f fiscal stimulus. The PER seeks to identify what critical and realistic short and longer term measures can be implemented in this regard to achieve this objective. Thus, the PER i s intended to provide a succinct and actionable view of the main priorities in public expenditure reforms that lie ahead, drawing on the lessons of comparable global experience and the particularities o f Lebanon. In the process, it i s expected to provide a means o f discussing with the Lebanese authorities various options on addressing key areas o f public expenditure reforms,
5. This Public Expenditure Review does not come alone, and benefits from many parallel ongoing activities: beyond the World Bank’s last reviews o f capital (1995) and social expenditures (1999) - whose main recommendations remain s t i l l largely valid (and are therefore only briefly discussed), we rely in this report on the Country Financial Accountability Assessment (CFAA) and the Pension Report recently completed by the World Bank (World Bank 2005a, 2005b), the Policy Note on Fiscal Stabilization transmitted to the Ministry o f Finance in November 2004 (World Bank 2004a), the Debt Management and Hydrocarbon Strategy Reports (World Bank 2004b, 2004d) as well as o n the IMF’s Public Expenditure Management Report (IMF, 2004). Thus, this review does not intend to repeat in details the findings o f these documents; rather, i t i s aimed at examining public expenditures with a view to: (i) assist the fiscal transition, (ii) reinforce safety nets and the targeting and coverage o f social spending, and (iii) develop modern capacity in the provision o f public goods. 6. This Public Expenditure Review i s organized as follows. Chapter Iprovides the macro-economic framework and discusses the need for fiscal adjustment. Chapter I1 looks for possibilities to contain primary expenditures in the next five years. Chapter I11 reviews the efficiency for current social expenditures, and explores ways to improve their efficiency with the view to (a) better support human development during the ordinary course o f the economy and (b) prevent human capital deterioration during any possible economic crisis. Finally, Chapter IV discusses options to improve civil service and move towards performance budgeting in the medium-to-long run.
12
Chapter I.Fiscal Adjustment for Growth3 The Immediate Challenge: Fiscal Adjustment for Growth and Poverty Alleviation
7.
Current public fiscal deficits and debt level remain far too high in Lebanon and undermine the country’s potential growth performance. In Lebanon, public deficits have been well above 10 percent of GDP on average over the period 1991-2004 (see Annex I), and the public debt to GDP ratio, roughly estimated at 165 percent o f GDP by end-2004 - and even closer to 200 percent i f account i s made for Government’s arrears and Central Bank debt o n a consolidated basis, i s the highest in the world. International experience suggests that persistently high public deficits and debt strongly reduce long-term growth. The empirical literature o n the impact o f fiscal policy on long-run growth is considerable, and its conclusions are mixed, as fiscal policy can influence growth through different channels4. However, fiscal deficits and debt, once they reach very high levels, incontrovertibly exert a strong net negative impact on growth. For example, a study on 39 developing countries in the 1990s (Baldacci et al., 2003) finds that increasing the fiscal deficit by 1 percentage point o f GDP led on average to a decrease in per capita real economic growth o f a 0.2 percentage point, in countries where the deficit initially exceeded 2.5 percent o f GDP. Applied to Lebanon, this result would mean that public deficits recorded over the past decade may have cost 3 percentage points o f foregone real per capita GDP growth every yearV5Similarly, another study (Patillo et al., 2004) finds that the size o f external public debt begins to have a strong negative effect on growth once i t exceeds 35-40 percent o f GDP. The typical channels or reasons for these strong negative effects are persistent government borrowing requirements that raise real interest rates to considerably higher levels, and/or inflation and/or rising macroeconomic risks o f financial crisis (associated with higher debt) that crowd out and reduce private investment (and in turn private capital accumulation and productivity growth). H o w big these effects have been in Lebanon cannot be precisely measured, but it is certain to have been a major cause o f the crisis in growth and social conditions over the past decade.
8. The debt situation i s at the heart o f the Lebanese long-term growth challenge, and should not just be seen as a financial problem. Public deficits and rising debt have most likely contributed to the sharp deceleration o f real GDP growth - less than 3 percent annually o n average since 1997, following the initial post-war boom o f reconstruction in the early 1 9 9 0 ’ ~ . ~ This chapter draws heavily o n W o r l d B a n k (2004a), and subsequent discussions with the M i n i s t r y o f Finance. One can generally distinguish three types o f channels through which fiscal policy affect economic activity: the effects o f public services and investment o n the productivity o f the private sector; the effects o f the tax system o n resource allocation and incentives, and the effects o f public deficits and borrowing o n the private sector. Lebanon has exceptionally strong comparative advantages that should allow m u c h faster longer-term real GDP growth, w e l l above 5 percent every year. These include strong entrepreneurial skills, high human capital, an open economy, a favorable geographical position and a m o d e m financial sector able t o attract large foreign investment, which should help Lebanon base t o future growth o n the development o f a modem, competitive and outwardoriented economy. All these characteristics are considered in the long-run growth empirical literature as findamentally favorable to growth (see Barro and Sala-I-Martin, 1995, or Sachs and Warner, 1997, for instance). In contrast, the same literature underlines the negative impact o f h i g h government deficits and poor institutional framework o n long-run growth. Official national accounts time series d o not exist in Lebanon. W e rely in this report o n MoET’s preliminary estimates for the period 1997-2004.
13
Broadly speaking, the post-war economic history o f Lebanon can be split into two sub-periods. In the period 1992-2000, GDP growth continuously decelerated, following a typical pattern o f debt crisis7, whereby high interest rates and risks discourage private investment and reduce fiscal space for public investment (see Table 1: between 1997 and 2000, total investment as a share o f GDP went down from 30 to 21 percent). Since the year 2000, the situation has become more complex, The debt continued to grow, but i t s impact on interest rates was mitigated by (i) greater resort to foreign-currency denominated debt instruments*, (ii) debt restructuring efforts, with the assistance o f the international community and Lebanese banksg, (iii) and significant efforts from authorities to bring up the primary surplus (see Table l), maybe triggering non-Keynesian confidence effects (see below). The real economy" was also helped by an unusual combination of favorable external shocks - continued low global interest rates and high regional inflows o f capital and tourism in particular." In Lebanon itself, in spite o f rapid broad money growth, banking credits to the domestic private sector have actually decreased in real terms since 2000,'* illustrating the absence o f domestic investment counterpart to the current positive external shocks. The bulk of private investment finds little room in which to base its potential for growth in Lebanon, other than non-traded goods and services - real estate and government debt.
Between 1992 and 2000, public debt ballooned f r o m an initial 35 percent t o 150 percent o f GDP, the result o f large capital expenditure investments, explosive growth in public sector employment and social spending. Taken together, these three economic and social reconstruction-related developments added some cumulative 75 percent t o the stock of debt t o GDP, while the remainder was the accumulation o f interest o n debt. In the face o f the increasing dollarization o f the deposits base, the Government o f Lebanon (GoL) had little choice but to swap towards foreign currency-denominated debt instruments (Eurobonds, with lower remuneration, as the exchange rate risk i s perceived to be eliminated). The G o L started to use such instruments in December 1993, and until August 2000, the share of total public debt labeled in foreign currency ranged between 10 and 25 percent, Since then, this share grew up regularly, t o reach approximately 50 percent nowadays. Following the Paris I1 conference in November 2002, donors contributed US$2.4 b i l l i o n t o debt restructuring (15year dollar denominated Eurobond rates at concessional terms), and commercial banks US$3.6 billion (2-year Treasury Bills at zero-interest rates), while the Central B a n k wrote-off U S $ l . 8 b i l l i o n w o r t h o f Treasury Bills f r o m its books. lo Real GDP growth in Lebanon was estimated at 5-6 percent in 2003 and 2004, the result o f significant private net capital inflows, sustained demand for domestic goods and services, and booming exports o f goods (towards Iraq) and services (tourism in particular). Yet, the long-term average growth rate in Lebanon i s believed to be m u c h lower, at 2-3 percent, and the current performance probably corresponds t o a high phase in the business cycle. Longterm growth i s impeded by (i) strong D u t c h disease effects stemming f r o m massive capital inflows; (ii) high real interest rates and investment risks in the face o f unsustainable public debt; and (iii) a poor investment climate (inefficient utilities and public service delivery, monopolies, corruption, etc). F r o m 3.6 percent o n average in the 199Os, real G D P growth in the MENA region went up t o 6.1 percent in 2003 and 5.2 percent in 2004 (World Bank, 2 0 0 5 ~ ) . l2Between December 2000 and December 2004, banks' credits t o the private sector grew up by 8 percent (source: Banque du Liban, BdL). During the same period the consumer price index rose by approximately 10 percent (9.6 percent according to the Consultation and Research Institute, 11.4 percent per M o E T ' s preliminary estimates), and money supply (M3 plus n o n residents' deposits) grew up by 47 percent (source: BdL). N o n perfonning loans are also reported to be high, reflecting the poor quality o f the private investment activity.
*'
14
Table 1. Macro-Economic and Fiscal Developments, 1997-2004 Gross domestic product (US$ billion) Real GDP growth (%)
1997 15.6 3.6
1998 16.9 2.3
1999 16.9 -1.2
2000 16.6 1.1
2001 16.9 4.2
2002 18.4 2.9
2003 19.9 4.9
2004 21.8 6.3
Private consumption (% of GDP) Private investment (% of GDP) Public consumption (% of GDP) a/ Public investment (YOof GDP) a/ Exports (% of GDP) Imports (% of GDP) Current account balance (% of GDP)
88.1 22.8 16.5 7.0 13.9 48.0 -30.6
88.7 22.4 15.4 6.7 13.0 41.8 -23.4
85.6 19.3 16.3 4.1 13.4 37.2 -19.1
82.4 16.1 17.2 4.9 13.6 37.2 -18.2
88.7 17.0 17.1 3.8 15.3 41.2 -19.9
85.7 15.9 17.0 3.9 15.9 36.1 -17.8
83.4 17.6 15.2 4.0 17.3 37.3 -20.3
82.2 18.1 15.0 4.2 21.3 41.4 -18.9
Revenue (% of GDP) 15.7 17.6 19.5 19.0 18.2 21.0 22.2 22.9 Primary expenditures (% of GDP) a/ b/ 25.7 19.7 21.0 26.9 19.0 20.6 19.7 20.6 Debt expenditures (YOof GDP) 14.5 13.1 14.2 16.8 16.9 16.7 16.3 12.3 Primary balance (% of GDP) b/ -10.0 -2.1 -1.5 -7.9 -0.8 0.4 2.5 2.3 Overall balance (Oh of GDP) -24.5 -15.2 -15.7 -24.7 -17.7 -16.3 -13.8 -10.0 Public debt (% of GDP) 97.8 109.5 132.5 150.7 166.8 170.8 167.7 164.8 Source: World Bank Staff calculations based on MoF, MoET and BdL. Figures are on cash basis (Le do not include arrears). ai T h e sum o f public consumption and investment might differ from primary expenditures, as the former i s subject to national accounts definition and does not include foreign-financed capital expenditures. b/ Transfers to EdL to cover i t s debt service and principal debt repayment are here considered primary spending. Foreign financed capital expenditures are included in primary spending.
9. The negative impact o f fiscal imbalances on growth i s compounded by structural problems. Concomitantly, deep-seated structural barriers to the growth o f a competitive and vibrant private sector also hobble the growth potential o f the economy. These range from very poor, inefficient and loss-making public services in power, water, customs and ports, to undeveloped and inefficient public services in education, health and other social sectors (see Chapter 111), and a configuration o f inefficient and costly regulatory barriers to private investment activity, including significant monopolies and a pegged exchange rate that hurts the profitability and competitiveness o f key sectors o f domestic employment and growth such as agriculture, tourism and other services. The cost o f non-action i s high and rapidly growing. With slow growth, social conditions and inequalities are ~ o r s e n i n g ' ~unemployment ; i s growing, prompting young The severe fiscal adjustment undertaken in the recent generations to emigrate in large number~'~.
10.
l3 There are n o reliable indicators o f trends in unemployment, poverty o r social conditions in Lebanon. Nonetheless, most accounts point to deteriorating social conditions. What i s known about poverty i s s t i l l limited to surveys f r o m several years back (CAS, 1997). At that time, poverty incidence was estimated by the Bank at over 20 percent o f a l l households, with rates varying f r o m as h i g h as 25-50 percent in the poorest districts o f N o r t h Lebanon, Bekaa and South Lebanon. Real per capita income growth for Lebanon as a whole has been since close to nil, and probably negative in some o f these poorest areas, since, in contrast, Beirut and M o u n t Lebanon seem to have benefited f r o m the current economic upturn (as evidenced for instance in construction activities). This could suggest that poverty rates have risen since 1997 in the poorest regions o f Lebanon, aggravating already high regional inequalities (UNDP, 2003). l4 Unemployment was formally estimated by the International Labor Organization at about 9 percent in 1997. Kasparian (2003) estimated that the unemployment rate rose t o 12 percent in 2001, mostly the result o f higher unemployment among women (at 18 percent in 2001 against 7 percent in 1997). Unemployment rates for young
15
years - through VAT notably - impacts the purchasing power o f the most vulnerable households who do not see in return greater social benefit^.'^ In addition, high and unsustainable debt levels entail very large risks o f financial disruption - and induced economic recession. Past experience around the world systematically demonstrates that private markets cannot indefinitely accommodate rising public debt ratios. Even the most faithhl investors can eventually lose confidence in the Government's capacity to honor i t s debt, and a major crisis then ensue, with potentially devastating effects on economic and social fabrics, as evidenced by the international experience (see Table 2). Table 2. Duration, Output and Fiscal Losses o f Financial Crises, 1994-2003. Number of crises Average duration (years) Fiscal cost (%GDP) Output loss (OhGDP) All countries 30 3.7 18 17 Emerging market economies 23 3.3 20 14 Developed economies 7 4.6 12 24 Banking crises alone 11 3.3 5 6 Banking and currency crises 19 4.1 25 30 Source: Carstens et al. (2004). Notes: the output loss i s the cumulated deviation from trend growth three years after the crisis. T h e fiscal cost corresponds to that o f banking resolution.
In Lebanon, the public debt dynamics i s such that sooner or later, the Government will no longer be able to service it. Comparison with countries having experienced fiscal/financial crises in the recent years (see Figure 1) indeed suggests that Lebanon i s by all accounts (fiscal, external, and the debt stock) in a worst pre-crisis situation than most o f its comparators.'6 In this context, Lebanon has no alternative but to seize all opportunities to immediately reduce the deficits and debt levels to considerably lower levels.
adults in the age group 15-24 are also at least twice the national levels. Thirty-eight percent o f active adults aged 35 or'less (and 58 percent o f unemployed active adults aged 35 or less) envisage emigrating. Between 1996 and 2001, 32,000 persons (1.5 to 2 percent o f the total active population) could have emigrated every year (against 21,000 between 1991 and 1995), most o f them for economic reasons (Kasparian, 2003). l5The deadly riots o f M a y 2004 - following the rise in o i l prices - clearly illustrated the social disaffection o f many groups, and their growing opposition to fiscal adjustment, the latter being solely perceived as a net transfer from taxpayers to debt holders. l6 O n the other hand, Lebanon probably benefits from the fact that most o f i t s public debt i s intermediated by domestic banks, which have large access to foreign savings (commercial banks' deposits represented 3 11 percent o f GDP b y end-2004; and current account deficits have been well above 20 percent o f GDP o n average since 1992) from the Lebanese Diaspora and Gulf countries. Over the years, the banking sector has progressively become locked into financing the growing public sector financing needs (by year-end 2004, more than half o f commercial banks' assets were invested in Government Bonds or placed at the Central Bank), and has found itself trapped into a situation where i t becomes critical for i t s own viability to maintain the solvency o f i t s most important client, the Government. This country-specific characteristic could explain to some extent the greater resilience o f the Lebanese financial system to what i s perceived to be an unsustainable debt dynamics.
16
Figure 1. Economic Performance in Fiscal Crisis Countries Real GDP Growth
%
%
15 1
iK
Lebanon
.-
1998
1999
2000
L
(5)
2001
I
2002
W
*< : ) o l ( (15) (20)
-
(25)
-
2003
El
10 5
2004
1998
x
I,, "
Current Account Deficit as Share of GDP
180 160
A
140
1
1999
2000
2001
2002
2003
Public Debt as Share of GDP ?
2004
Lebanon
/
:q & P r".
': :
40
1998
1999
2000
2001
2002
2003
2004
Source: World Bank staff calculations
Cutting Primary Expenditures and PrivatizingPublic Assets
11. Further fiscal consolidation will require a drastic containment in non-debt expenditures. Privatization and tighter debt management17 will not suffice to put the debt to GDP ratio on a steep declining curve, unless accompanied by a much higher primary surplus. The level o f the primary surplus needed to stabilize the debt to GDP ratio varies in time, with interest rates and the GDP, and i s therefore difficult to identify accurately. Nonetheless, debt sustainability analysis conducted by the World Bank concludes to the need to raise the primary surplus above 10 percent o f GDP (up from approximately 1 to 2 percent in 2004, including arrears) to simply stabilize the debt (including arrears, at approximately 10 percent o f GDP by end-2004, see below) to GDP ratio. The deterioration o f the financial situation in Lebanon following the assassination o f former P M Hariri (February 14, 2005)18, and the announced rise in global interests and deceleration o f economic activity in the MENA regionIg make this general
l7 Debt management can b e improved in many ways, notably in order t o reduce interest rates, currency or rollover risks, (see W o r l d Bank 2004b). But it cannot pretend t o significantly reduce the public debt service in the absence o f macro-economic adjustment. See B o x 1 o n debt management. l8 In the two months following the assassination o f former P M Hariri, U S $ 5 b i l l i o n w o r t h o f LBP-denominated deposits were converted into foreign currencies, US$2 b i l l i o n left the country, and domestic interest rates basically doubled, severely undermining already weak GoL and BdL medium term financial positions. l9Lebanese merchandise exports and the coincident indicator o f economic activity developed by the Central Bank exhibit both a strong (co-integrated) correlation with w o r l d o i l prices. W o r l d B a n k econometric analysis also suggests a strong correlation between the LIBOR and Lebanese deposits rates (inUS$; source: ABL). On average, a 100 basis points increase in the LIBOR induces a 75 basis points increase in deposits rates labeled in US$. MENA
17
statement even more valid today. Increasing the primary surplus will necessarily require cutting back o n primary expenditures. Clearly, in the face o f the adjustment needed and the relatively small size o f primary public spending, large tax increases would need to accompany (and even probably precede, given the difficulty to rationalize expenditures in a very short period) expenditure cuts, and are technically feasible through the introduction o f a global income tax or increases in VAT and other taxes’ rates for instance.20But after several years o f continued efforts to raise fiscal revenue (see Annex 1: between 1997 and 2004 tax revenues as a percentage o f GDP went up from 11 to 16 percent), this might be politically challenging unless accompanied with a serious public expenditure containment which would not lead the private sector and households to bear alone the whole burden o f adjustment. World Bank staff calculations (see Chapter 11) suggest that bold expenditure reform would permit to contain nominal growth in expenditure at approximately 2 percent a year. In these conditions, raising up the primary surplus to 10 percent o f GDP would require increasing the tax pressure to 27 percent o f GDP (up from 23 percent in 2004) with a 5 percent annual growth rate in nominal GDP; to 25 percent with a 7 percent annual growth rate in nominal GDP; and to 29 percent o f GDP with a 3 percent annual growth rate in nominal GDP. 12. M o r e importantly, cutting back on unproductive and inefficient expenditures will send a strong and credible signal of Lebanon’s commitment to address at its roots its fiscal imbalances and improve its overall use of funds - or better governance, an indispensable condition to preserve growth and convince potential contributors (debt holders, the international community, etc.) to assist Lebanon in i t s efforts to adjust. International experience indeed suggests that fiscal stabilization which concentrates on unproductive expenditure cuts rather than tax-based adjustment i s more likely to succeed in reducing the debt to GDP ratio2’. Tax increases, if distortionary, will permanently affect growth. On the contrary, the short-run negative impact on output of expenditure cuts (through multiplier effects) is likely to turn positive in the medium-long-term, in anticipation o f higher disposable income (see below). This in turn calls for cuts in wage-related and transfers expenditures (pensions or subsidies to public enterprises for instance, see Chapter 11) which are rather permanent (less flexible) in nature and thus reinforce the credibility and durability o f the adjustment and i t s impact on disposable income prospects.
~~
GDP growth i s forecasted to decelerate from 5.2 percent in 2004 to 4.3 percent in 2006 (and o i l prices to drop 5 ercent). In the same time, the U S $ L I B O R i s forecasted to jump by 300 basis points (World Bank 2005~). According to the Ministry o f Finance, the long-awaited global income tax (as envisaged since 2002; see Republic of Lebanon, 2002) could now be implemented rapidly. The threshold o f VAT exemption could be fiuther lowered and i t s rate increased. The tax on interest income could also be increased. Other important sources o f taxation, on land property and transactions for instance, could be contemplated by the Authorities. The implementation o f the professional tax, which was adopted by the Parliament in 2001, i s still pending. European Commission 2003, McDermott and Wescott (1996).
18
19
13. Privatization should accompany fiscal adjustment, with a view to primarily promote growth. For heavily indebted countries like Lebanon, i t i s critical that privatization proceeds be used to reduce the debt. But a cautionary remark i s called for here: when privatization proceeds are used to retire debt, the Government should ensure that this i s done as part o f a package o f measures that are sustainable from the financial point o f view in bringing the stock o f debt down. Otherwise, the reduction in interest payments will be short lived, and a perverse debt dynamic will resume as soon as privatization proceeds run out. The potential privatization proceeds will therefore be wasted if they are not used in the context o f an overall fiscal consolidation agenda. In addition, privatization should aim in priority at promoting cost effective private service delivery. Any Government faces substantial pressure to maximize privatization revenues, and the first measure by which success o f the sale i s likely to be judged i s the sale price. However, the incentive to increase the sale price might be at the expense o f future improvement in the service. There are at least two ways o f boosting the sale price at the expense o f the future. First, the Government might be tempted to grant whole or partial monopoly privileges to new private incumbents, Indeed, international evidence on telecom privatization suggests that when Governments sold monopoly concessions, they generated twice as much on average as they did when they granted non-exclusive contracts, but this was at a tremendous cost to the performance o f the sector and growth o f the economy. Second, a Government may request less in terms o f future capital investment outlays, which would boost the sale price. Both strategies are dangerous, especially in sectors as critical to the economy as power and telecom. As tempting as i t i s to measure the efficacy o f privatization in terms o f sales price, i t i s the long-term impact on quality and price o f service, and i t s contribution to spurring growth and economic development that i s most critical. The Impact of Expenditure Containment on Growth: Keynesian versus Credibility effects
14. Growth, though, might be hurt in the process. Lebanon cannot ignore the potentially negative impact o f public expenditures containment o n economic growth in the short-run, through a contraction in aggregate demand (Keynesian effect).23 The extent to which GDP will contract will in turn depend on the reaction o f domestic interest rates.24 A large decline in
In a standard Keynesian model (IS-LM, considering the real and money markets’ effects o f the fiscal multiplier and the nature o f the exchange rate regime) contractionary fiscal policy affects domestic demand, unless the positive effects o f lower deficit financing foster investment and private consumption through lower interest rates. In Lebanon, the issue i s rendered more complex by the fact that interest income represents a significant share o f households’ disposable income - some 10 percent in 1997. As a result, the positive impact o f declining interest rates o n investment and private consumption could be somewhat offset by lower households’ disposable income (wealth effect). 24 W o r l d Bank simulations using a simple Keynesian model illustrate this fact. A five percent decrease in public absorption would entail a 1.5 percent decline in G D P with unchanged interest rates. In contrast, the decline in G D P would be m u c h more modest, 0.5 percent o f GDP, if interest rates were to drop by 200 basis points during the same time. 23
20
interest rates during fiscal adjustment would minimize i t s short-term cost for the economy - and would possibly make i t easier to pursue throughout several years. But several elements could prevent a rapid decline in interest rates. First, barring a credible fiscal adjustment program, reduced public consumption would not necessarily entail a large drop in the Government’s financing needs. While, in a typical setting, lowered government consumption would reduce by a large amount its financing needs - thereby exerting a downward pressure on interest rates, this shall not be so much the case in Lebanon given i t s high indebtedness level. Indeed, strictly speaking, interest rates are not determined by the deficit level, but by the stock o f public debt more than seventeen times higher as o f end-2004. Accordingly, reducing by 5 percent primary expenditures would reduce the public deficit by 11 percent, but would only reduce the Government’s financing needs by 1 percent. Second, capital i s highly mobile in Lebanon and reacts rapidly to change in remuneration and perceived risks (World Bank, 2004). In this case,
reduced Government’s financing needs (money demand) will only exert a minor impact on interest rates if money supply is declining simultaneously with lower net capital inflows. Finally, commercial banks’ immediate ability to fillly convert loans to the Government26 into investment and consumption loans to the private sector i s questionable, in the face o f their already high level of exposure to the private sector.27 So far, loans to the private sector are in vast majority labeled in U S Dollars and covered with high collateral requirements.28 Hence the potential for further decline o f lending interest rates in U S Dollars is most likely lower than that in Lebanese Pounds (as the exchange rate risk could decline with fiscal stabilization). Besides, developing investment banking will take time, as most banks do not yet have sufficient capacity to assess the economic value o f a large number of investment projects (specially with SMEs) and to take risks accordingly. Consequently, new savings available for loans to the private sector might actually be lower than those released from Government’s books.
15. International evidence o f fiscal consolidation, however, sometimes contradicts these predictions o f short-term negative impact on growth. Theoretical predictions (for which restrictive fiscal stances would result in short-run negative impact on aggregate demand) were not always supported by the facts. Growing evidence has been accumulated that the value o f fiscal multipliers i s likely to be small and falling over time and even sometimes opposite to those predicted by the theory. Cases have been notably documented o f EU countries in which tax increases or expenditure cuts have been followed by accelerated growth in the short-term (expansionary fiscal consolidation episodes), the two most famous cases being Denmark and Ireland in the 1980s. Even within the limited experience o f the Middle East region itself, successfill fiscal adjustment, debt restructuring and faster growth have sometimes accompanied each other. For example, in the early 1990s when Egypt was affected by an external debt crisis, a large restructuring o f debt and a deep fiscal adjustment were simultaneously responsible for resurgence in growth as confidence returned to the economy. Similarly in Jordan, the large reduction in public debt to GDP in the late 1990s and a relatively tight fiscal policy were 25 See for instance Drudi and Prati (2000), who link theoretically and empirically the interest rate t o the debt stock level (by opposition to the deficit). 26 By end-2004, commercial banks’ claims o n the public sector (Government and Central Bank) represented 163 percent o f GDP and 53 percent o f their assets. By end-2004, commercial banks’ claims o n the private sector represented 73 percent o f G D P (and 23 percent o f their assets). According t o professional bankers, Lebanon’s domestic credit market has n o w been saturated since 2000, and banks cannot significantly raise their exposure t o the private sector under current prudential regulations. 28 In January 2005, 82 percent o f commercial banks’ claims o n the private sector were labeled in foreign currencies.
’’
21
accompanied by a comparatively swift reduction in domestic interest rates and faster GDP growth - also helped by a reduction in international interest rates. However, in both cases, the debt restructuring was a critical component and was helped immensely by Paris Club debt negotiations; in the case o f Lebanon, with virtually all o f i t s debt privately and domestically held, there are no such avenues and the restructuring o f that debt has to happen within the institutional confines o f Lebanon i t s e l f - see below. 16. Analyses o f expansionary fiscal consolidation episodes underline the critical role of credibility. A number o f explanations were put forward to explicate the emergence o f expansionary fiscal consolidation through “non-Keynesian effects”.29 In particular, it seems that the reduction in budget deficit may lead to an increase in private consumption already in the short-term through wealth and confidence effects. In this sense, the credibility o f consolidation i s crucial, Le., the fiscal adjustment should be perceived to lead to a permanent increase in future disposable income streams via reduced taxation. Consolidations leading to a substantial improvement o f the budget balance, or starting from a situation o f high debt to GDP ratios3’ are more likely to improve consumers’ expectations. Fiscal consolidations may also affect investment positively, through higher expected profits with lower taxation. In most cases, the macro-economic environment preceding expansionary consolidations periods is characterized by slow growth and negative output gaps (large unused capacities), as i t i s the case in Lebanon at present.
17. The response of financial markets to greater fiscal credibility i s potentially high in Lebanon. Two episodes during the period 1991-2004 signaled that credible government actions might significantly lower the country risk (hence interest rates and the cost o f fiscal consolidation): the period immediately following Paris 11, during which interest rates have fallen dramatically, and the period between January 1999 and July 2000, during which the spread over the L I B O R (in US$)f e l l by one percentage point, probably following the decline in public deficit over GDP by approximately 10 percentage points in 1998 and 1999 compared with 1997 (see Table 1). Similarly, quantitative analysis conducted by the World Bank suggests that capital inflows are strongly responsive to the evolution o f the perceived economic country risk in Lebanon. Improved credibility o n the sustainability o f structural reforms could then foster a significant response in terms o f higher foreign capital inflows (World Bank, 2004).
29
See European Commission (2003) for a detailed discussion o f expansionary fiscal consolidation episodes. International evidence suggests that the higher the debt overhang, the greater the impact o f fiscal adjustment o n interest rates. Drudi and Prati (2000) defend the idea that bringing up the primary surplus i s particularly powerful in bringing d o w n interest rates when a country i s highly indebted. On the contrary, bringing up the primary surplus will have little impact o n interest rates if a country i s l o w l y indebted. This non-monotonic relationship between interest rates and the primary surplus stems f r o m the fact that governments have an incentive t o tighten their fiscal regime when the signaling effect o n credit ratings is larger (i.e. when a sufficiently large stock o f debt has been accumulated). This interactive effect between debt and the primary surplus o n interest rates was observed in OECD countries, as w e l l as in Brazil in the 1990s. 30
22
Policy Options
18. I n this regard, a successful policy-package should consider three essential elements: (i) the Authorities need to work o n improving the credibility o f their commitments in order to the investment climate needs to be improved reverse anticipations and lower interest rates; (ii) simultaneously to raise the potential response o f the private sector to better macro-economic conditions; and (iii) i t s political feasibility should be insured by an equitable distribution o f the burden o f adjustment across groups. With these conditions the short-term negative impact o f fiscal adjustment o n growth will be rapidly offset by its longer-term rewards. 19. T o raise anticipations of a successful fiscal stabilization, governance issues must be frontally addressed. The immediate negative impact o f fiscal stabilization plans on aggregate demand might be offset by enhanced anticipations o f a brighter economic future. Lebanon could be particularly receptive to a change in economic perceptions, as i t s potential to mobilize new financial resources - from abroad in particular - is huge. The communication element o f the package i s in this respect essential, and the ingredients o f a credible commitment are: clear objectives, an action plan, a timetable, publicly monitorable progress indicators, and full accountability for results. I t can be improved by (i) locking in the reform process in the signature o f binding international agreements3’ and (ii) improving the nature and transparency o f economic i n f ~ r m a t i o n ~The ~ . other element o f a credible policy-package i s to work on improving structurally the overall use o f public funds (transparency, accountability, medium term planning) - governance. The agenda i s large, but there are reforms which could rapidly pa o f f in terms o f higher credibility. It includes notably the enacting o f a fiscal responsibility law3 Y, the passage o f the procurement law, the full budgeting o f existing contingent liabilities (e.g. pensions, see Chapter 11) and the restructuring o f EdL. In the longer run, reforms to modernize the civil service, budget processes’ transparency and efficiency and the planning o f capital expenditures are needed (see Chapter IV).
20. I n parallel, there are several structural reforms which would improve the responsiveness of the private sector to better macro-economic conditions. While demand Such as the EuroMed o r WTO accession, which sets the rules o f competition and transparency? The signature o f structural adjustment loans programs with the IMF and the W o r l d B a n k also enhances the credibility o f consolidation plans as they are supervised by international bodies and rendered less painful with the credits provided by the institution to facilitate the adjustment. 32 Lebanon ranks 109” out o f the 117 countries o f more than 1 m i l l i o n inhabitants listed by the W o r l d Bank in terms o f statistical capacity. 33 M a n y countries have explicit fiscal rules and these pre-commitments to binding fiscal action are sometimes very important t o tie down accountable actions o n the part o f both the Government and the Parliament and other actors. These are most evident in the EU where member countries have tied themselves t o fiscal discipline (budget deficits not to exceed 3 percent o f GDP, and fiscal consolidation agreements in n e w l y accession countries) as a condition o f joining the EMU, with a n agreed framework for fiscal surveillance. In the UK, as well, a Code for Fiscal Stability and transparent policy objectives have been in force for some time, underpinned by two fiscal rules: a “golden rule” that allows Governments t o borrow only for investment and not current spending over the business cycle; and a “sustainable investment rule” to ensure that public debt remain at a prudent level. These two rules provide an overriding framework for budgets and fiscal actions. Elsewhere, fiscal Responsibility Laws have been enacted in Brazil, Peru, and Argentina and are planned in Colombia, Ecuador. Such laws do n o t prevent budget flexibility in the face o f unexpected shocks. Kuwait, for example, has set up a stabilization fund that i s built upon when conditions are favorable and drawn f r o m when they are n o t (ERF, 2002). 31
23
management will be key, the structural agenda should not be neglected. In the short run, fiscally neutral reforms should seek to improve the supply (investment) response to interest rates decline. Beyond privatizing public assets with a view to promote sound competition, there i s a large agenda to improve the response o f the private sector to a better macro-economic environment in Lebanon: reliable and affordable power supply; modem I C T infrastructure; efficient trade facilitation systems (including customs, border crossing, and transport logistics); a streamlined regulatory system for business entry, operation, and exit; modem corporate governance and capital market regulations; protection o f intellectual property rights; and a legal framework to ensure competition in competitive markets as well as for restricted markets (utilities, public services, and natural monopolies). Some o f these reforms could be undertaken in the short run at l o w fiscal cost. 21. But at the end o f the day, reducing the debt remains a political challenge, which will require a strong consensus among stakeholders. Good technical solution, although obviously needed, will nevertheless not suffice. Recent episodes o f fiscal adjustment attempts in Lebanon the inability to sustain in the budget 2004 the efforts initiated with Paris I1 for instance illustrate the limits o f a technical program not supported by a strong political consensus. By contrast, successful fiscal stabilization episodes in the world have all been achieved by strong, cohesive and determined executive powers, benefiting from sufficient political support to sustain adjustment efforts over several years (Nabli, 2004). This will necessarily require equitably sharing the burden o f adjustment and reinforcing social protection. A stabilization plan which would let the poor bear the full burden o f adjustment would be short-lived, as it could not generate broad-based support for reform.
22. Enhanced social protection in the transition i s important, given that fiscal consolidation might have a negative impact o n employment in the short run. There i s a strong political economy value as well as economic reasons to enhancing social protection measures in the immediate phase o f spending declines. These could include community development programs targeted at ensuring greater access to social services (education, health, etc.), regional programs targeting the poorest areas, and conditional cash transfers. In the longer run, the overall social protection strategy needs to be re-evaluated (See Chapter 111). In addition, immediate protection for public sector employees o f privatized enterprises will need attention. Public utilities currently employ large numbers o f employees, who are bound to comprise a sizeable political deterrent to privatization. I t i s essential that the process be managed up-front. Without agreed actions, few bidders are likely to emerge for some o f the over-manned and over-staffed employees. Options include absorbing surplus employees in other departments temporarily, voluntary retirement schemes, and involuntary redundancies over time with compensation payments. Paying for such expanded programs should be part o f the agenda on the design o f fiscal adjustment programs. 23. Privatization should benefit the population. The privatization program should seek a good compromise between its economic (cheaper and better utility costs) and financial (the reduction o f the debt stock) impacts. But one could also make sure that debt retirement particularly favor the poor and vulnerable sections o f the society. Thus, privatization revenues could be prioritized to the reimbursement o f the Treasury Bills portfolios in Lebanese Pounds o f both the National Social Security Fund (mainly pension fund reinvested surpluses) and the
24
Institute o f the Guarantee o f Deposits. In the first case, the pension o f thousands o f workers would be disconnected from the debt risk. And in the second case, the small depositors would be protected, as the amount guaranteed does not exceed four thousand U S Dollars per depositor, which i s equivalent to the average deposits o f more than two-thirds o f the Lebanese depositors. Setting l o w tariffs and connection fees for basic privatized services will also be imperative for poverty a ~ l e v i a t i o n . ~ ~
24. Debt holders should contribute to the effort of adjustment. Each segment o f the society would seek to have the other pay the price o f adjustment. I t i s in effect a “prisoner’s dilemma” where all segments will gain from cooperating, and lose in the end if each side sought to evade the cost. But overall losses would be significantly reduced if spread across the society. For an adjustment to be politically viable, those who have benefited from the debt would have to contribute to the cost o f adjustment in a manner proportional to the profits earned. Otherwise the program would most likely fail politically, as it would be perceived as a net transfer from the vast majority (the taxpayers, the civil servants) to the happy few holders o f the public debt. The fact that Lebanon’s debt i s largely domestic i s helpful in this regard, as it i s in the interest o f creditors to maintain financial, social and political stability. In 2003, commercial banks probably contributed to the efforts o f stabilization as some prerequisites were met: commercial banks’ efforts were part o f a broader effort, with clear commitments from the Government, donors and the Central Bank; and collective bargaining prevented free-riding behaviors. In the event, banks benefited from greater financial stability to double their disposable profits. As banks’ exposure to sovereign risk is very high, i t is again in their utmost interest to preserve the solvency o f their principal debtor, the Government. In this respect, the latter could hrther exert i t s monopolistic power to convince banks to contribute more to the overall effort o f ~tabilization.~’Beyond their positive influence on the political feasibility o f the adjustment, these actions would also directly contribute to the adjustment in the form o f lower debt service. 25. Expenditure rationalization cannot guarantee fiscal stabilization, but remains crucial for growth. Given the size o f Lebanon’s current fiscal imbalances and debt stock, bold expenditure reform alone is most likely not a sufficient condition to restore fiscal sustainability. Tax increases, privatization, debt restructuring and the financial support o f Lebanon’s friends are also needed to bring back the debt to GDP ratio to more quiet waters, but are not granted. In Jamaica, a decade o f bold fiscal adjustment has not succeeded in curbing down the debt dynamics36. And at any time a confidence shock could eliminate the long and p a i n h l efforts 34 The key to a pro-poor privatization policy i s two-fold. First, ensure competition and an effective regulatory framework to ensure efficient delivery o f the service. Second, explicitly take into consideration the poor fractions’ ability t o pay. Policy choices largely depend o n existing conditions. F o r example, i f most o f the poor are already connected t o the service, then they tend t o benefit more if the tariffs are chosen as the competitive variable in a concession process. In contrast, if most o f the poor segments are n o t connected, then requesting target connections o r target capital investment commitments have a higher potential o f benefiting the poor. Choices also include a subsidy policy, whereby connection fees can be subsidized, or tariffs be designed t o ensure a l o w rate for basic needs, and then progressively increase for higher rates o f consumption. 35 Various options could be envisaged in this regard, f r o m debt restructuring (as i t happened after Paris 11) t o raising the interest rate tax (currently at 5 percent o f interest income), which allowed in 2004 the collection o f 0.7 percent o f GDP. 36 In spite o f a primary surplus o f 10 percent o f GDP o n average over the period 1993-2003, the debt t o G D P ratio went up f r o m 114 to 149 percent during the same period. Slow growth, a financial crisis and the political difficulty t o maintain consistently fiscal efforts throughout a l o n g period (in 1996, the Government raised significantly the
25
undertaken by Lebanon to bring up i t s primary surplus, as vulnerabilities will remain high in all circumstances in the foreseeable future. 37 Hence expenditure containment for i t s own sake could look irrelevant in the face o f i t s high political and social costs, and additional objectives attached to it are required to justify it in all circumstances: (i) improving Lebanon’s growth potential through a better public service delivery and investment climate and (ii)reinforcing social protection are the natural candidates. Indeed, several important structural obstacles to growth and social protection are directly related to poor public expenditure management (unproductive public administration, corruption, ineffective resource allocation, and poor management o f public enterprises) 38. In other words, large spending in some sectors i s the symptom o f inefficiencies and weak governance, and expenditure reform, if properly designed, can prove to be a very powerful means to foster growth and alleviate poverty, beyond i t s impact o f protecting against financial crisis.
wage bill and primary spending) illustrate the downside risks o f any fiscal adjustment program (World Bank, 2004~). 37 Simulations suggest that a reasonable combination o f b o l d fiscal adjustment measures, debt restructuring, privatization and donor assistance could bring back the debt to G D P ratio t o approximately 150 percent o f G D P in a five-year period, assuming n o confidence shock along the road. 38 The revenue side i s n o t the subject o f this PER. Nevertheless, i t is believed that a r e f o r m o f the tax system could also significantly help mitigating inequalities and distortions.
26
Chapter 11. Containing Primary Spending: What Can Be Done?
26. The functional classification structure of the budget reflects Lebanon’s priorities; the economic classification the means to achieve it.39While the former is o f the sovereign domain and relates to choices that go beyond the scope o f a public expenditure review (such as military spending for instance), the latter can always be discussed on efficiency and sustainability grounds. Furthermore, the functional classification does not necessarily match outcomes in Lebanon. Social spending, for instance, i s not only the aim o f the ministries o f Education, Social Affairs and Health (see Chapter 111). Other ministries contribute as well to social spending, making the functional classification difficult to interpret from a performance point o f view. Besides, most o f the problems currently faced in the various administrative entities (ministries, agencies, etc.) are common in nature, and very often related to governance issues. From this perspective, i t makes sense to look primarily at the budget through i t s economic - to identify classification, and try - with a view to support fiscal consolidation (see Chapter I) where sources o f savings could potentially l i e in the following categories: (i)wage, salaries, benefits and (ii) pensions o f civil servants, militaries and contractual workers, (iii) transfers to extra-budgetary entities, (iv) other current expenditures and (v) capital expenditures, without affecting the provision o f public goods. Table 3. Economic Classification of Public Primary Spending Wage, salaries and compensations (% of GDP) Pensions (% of GDP) Transfers to extra-budgetary entities (% of GDP) a/ Other current expenditures (% of GDP) Capital expenditures (% of GDP) b/ Other primary expenditures (% of GDP) cl Total primary expenditures (YOof GDP)
2000 8.3 3.4
2001 8.4 3.3
2002 7.8 3.1
4.1 3.8
2.4 0.9
26.9
19.0
2.9 2.0
2003 7.5 2.8 2.5 2.4 3.1 1.5
2004 7.0 2.5 2.9 3.2 3.2 I.9
20.6
19.7
20.6
Source: World Bank staff calculationsbased on MoF and MoET. Expendituresare on cash basis (Le. exclude arrears). a/ transfers to EdL to cover their debt service and principal debt repayment are here considered primary spending; b/ capital expenditure includes CDR expenditures. c/ other primary expenditures mostly encompass the settlement o f arrears and carry-overs. See Annex Ifor further details.
Wages 27. Wages and Salaries (including benefits, advances, compensation, but excluding pensions) o f civil servants, military forces and Government’s contractual workers represent 7 percent o f GDP and 34 percent o f primary expenditures. Public wage expenditures in Lebanon are not particularly high by international standards (compared to 8 percent o f GDP on average in middle income countries), and any attempt to modify frontally their structure i s likely to face fierce opposition - hence producing little chance o f success in Lebanon’s current political environment. This i s even more so since public wages are apparently
39
See Annex 1 for a detailed report o f functional and economic classifications.
27
l o w in absolute4’ and relative terms41, and have been de facto frozen (along with hiring in the civil service) since 1997.42 Yet, the average age o f the Government’s civil (including non civil servant public employees) and military employees are respectively 42 and 33, and about 20 percent o f them could retire in the next 5 years (and 45 percent in the next 10 years) under current pension regulation^^^, so that i t might be advisable to work o n replacement policies (net flows) rather than on the labor force stock directly. Besides, the privatization o f some public functions (19 percent o f the public labor force works in State Owned Enterprises, see Chapter IV) should help lowering the overall public labor force. Replacing only two out o f three pubic workers retiring in the next ten years, halving the number o f contractual workers and privatizing the public electricity company in the next five years could eventually help Lebanon saving about 1.O percent o f GDP per year on its public wage bill. But this fiscal space should be used rapidly to modernize i t s civil service, once public needs are better defined and civil service reform i s forcefilly engaged.
28. Working on replacement policies calls for a reflection on employees’ functions. But reliable data on the number o f employees o f the public administration, their qualification or their geographical distribution do not exist. Despite numerous efforts to rectify this situation, there are four databases for public employees (these are at the C i v i l Service Bureau, the Ministry o f Education, the Armed Forces and the MoF) without systematic linkages between them. The M o F also manages the payroll but the extent to which the payroll matches actual employment i s not controlled, Any attempt to rationalize wages and wage-related expenditures will primarily require a civil service census o f the existing public labor force, approximately estimated at 220,000 (see Chapter IV).
Public employees (civil and military servants and contractual workers) received in 2004 US$31 per day o n average in PPP terms, to be compared with US$35 in Jordan for instance. 41 In the absence o f recent labor force surveys, it is difficult t o establish a strict comparison between public and private remuneration. National accounts for 1997 (MoET, 2003) report that labor compensation represented 4 1 percent o f G D P at factor cost (the remainder 59 percent are gross operating surpluses - profits). With 35 percent o f Lebanon’s population being active and an unemployment rate o f 11.5 percent (Kasparian, 2003), the average per capita labor compensation in the private sector would be 8 percent lower than that in the public sector (not controlling for personal characteristics) in 2004. But national accounts typically underestimate the real contribution o f labor to GDP, as they ignore invisible labor remuneration, such as the implicit labor income o f employers, unpaid family workers and self-employed workers, generally sizable in agriculture and services. Under the ( s t i l l conservative) assumption that labor remuneration could represent 50 percent o f GDP, then private sector per capita labor remuneration would be 16 percent higher than that o f the public sector. M o s t econometric estimates o f labor contribution to G D P in middle-income countries put this share between 50 and 7 0 percent. 42 The decision t o increase wages was passed at the Parliament in November 1998 but was never implemented. As a result, the Government built up the equivalent o f LBP1500 b i l l i o n worth o f arrears vis-&vis i t s employees, see below. 43 Thirteen percent o f the contributors to the c i v i l scheme are about to retire in the next 5 years and 3 0 percent in the next 10 years; 20 percent o f contributors t o the military scheme are about t o retire in the next 5 years and 43 percent in the next 10 years); 24 percent o f contributors t o the E O S I program are about t o retire in the next 5 years and 5 1 percent in the next 10 years (Source: W o r l d B a n k staff calculations). Under the assumption that public employees not contributing to the c i v i l o r military schemes (maybe 120,000 persons) are contributing t o the E O S I program and have the same demographic structure than the population o f a l l contributors t o the E O S I program, then it i s estimated that 20 percent o f the 220,000 public labor force could retire in the next five years. 40
28
29. Public employment accounts for approximately 18 percent of total employment and has effectively become an expanded social safety net in the post-war period with considerable overstaffing. This ratio i s very high by international standards and consistent with the observations o f (i) l o w individual remuneration in the public sector and (ii) moderate public wage bill as a percentage o f GDP. As emphasized in Chapter 111, a significant share o f Lebanon’s public social spending takes the form o f benefits for public employees (0.9 percent o f GDP and 15 percent o f public social spending, excluding pensions). Reducing the public labor force through attrition i s hence contingent on the development o f wider safety nets and sustainable pension schemes (see below and Chapter 111). 30. At the root o f the inability to rightsize public labor force i s the governance structure. A C i v i l Service Council was introduced in 1959 to take away personnel and hiring decisions from the different Government departments and Ministries. I t was intended to reduce favoritism and introduce merit within the Lebanese civil service. The council has a p o w e r h l board and i t s executive officer has the same powers as a minister. However, the authority o f the council has gradually been undermined and over time become largely paralyzed by sectarian politics. 44 This situation prevents i t from becoming the natural hub for reforms of human resource management in Lebanon.
31. The Government has no explicit employment policy nor any indication or assessment o f future staffing needs. In addition to lack o f reliable data about the current size o f the civil service, the Authorities do not have plans for human resources management or directions for future recruitment. Despite the large size o f the public administration, there are also chronic shortages in special skills. The extent to which Lebanon will be able to contain i t s public wage bill, thus, depends on forging consensus o n the role o f the State in the provision o f services. 32. Clarifying the role of the State i s crucial to overcome Lebanon’s political obstacles. Fragmented efforts to address public sector reforms are unlikely to succeed without addressing the issue o f civil service reform and reducing the size o f public sector employment. Current efforts focus o n combating corruption, improving the climate for private sector development and strengthening the regulatory powers o f the public sector. While these efforts are good in their own right, they may not succeed without clarifying the role o f the State. These measures individually have only marginal effects o n the situation o f public administration in Lebanon, yet taken together do not amount to much either, since they are touching at many reform areas, without solving any. A comprehensive multi-pronged approach i s required. 33. Unless the issues of recruitment, remuneration and retrenchment are addressed, the public sector will remain inefficient, costly and prone to corruption. The civil service i s currently over-staffed with people who have little training and who are unprepared to tackle the modem demands o f public administration. A new and aggressive human resources strategy, 44 In 1993, there were strong initiatives for reforms and some 3,000 employees were retrenched for n o t living up t o their obligations or were under-qualified for the positions they held. Since then, further retrenchment became politically rather difficult (see Chapter IV). Public hiring has traditionally played an important social safety net (see Chapter 111) and a political role in Lebanon, insuring a redistribution o f public resources across the various sectarian groups.
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which focuses o n the recruitment o f qualified staff and identification o f performing staff, i s needed to introduce new blood into the system. Human resources management reforms have to be conducted in accordance with changes in management practices and introduction o f performance management and monitoring into the civil service. These issues are discussed in Chapter I V.
34. Pensions and end-of indemnity services for civil servants, military and Government’s contractual workers account for 2.5 percent of GDP and 12 percent of primary public expenditure^^^. Various schemes co-exist: two defined-benefits pay-as-you-go systems for civil and military services, and an end-of-service indemnity (EOSI) program for government’s contractual workers. The latter is directly managed by the National Social Security Fund (NSSF), financed through capitalization, and also covers private (formal) sector workers. The two pension schemes for civil and military staff provide benefits higher than contributions and are therefore financially u n ~ u s t a i n a b l eTheir . ~ ~ combined deficit approached LBP8 10 billion in 2004 (2.5 percent o f GDP, entirely financed by the budget), and could reach LBP1225 billion in 2010 (2.8 percent o f GDP for a 5 percent annual GDP growth rate over the period 2005-2010) in the absence o f any major reform. The implicit debt o f the system has already attained more than 50 percent o f GDP (World Bank 2005b).48 The long term financial stability o f the end-ofservice indemnity program i s also not guaranteed, but has sufficient reserves to keep the system afloat until 2020 without entailing additional fiscal costs. This relative stability i s nevertheless conditioned on the reimbursement o f arrears (or i t s conversion into formal debt) accumulated by the Government vis-&vis the NSSF (some LBP867 billion or 2.6 percent o f GDP by end200449), and the avoidance o f new arrears. I t i s also conditioned o n the possibility for the NSSF to (i) protect its pension reserves from being diverted to financing other NSSF programs (e.g., health and family allowance, which cumulated a deficit close to 1.O percent o f GDP in 2003) and to (ii) optimize its financial placements from a risk and return perspective5’.
35. Reforming public pension schemes i s urgently needed, feasible, and could generate sizeable savings in the short run. Reforms o f the military and civil service pension schemes are possible, through parametric changes (e.g. gradually modifying contributions, benefits formula, or eligibility conditions). The system would remain open to new entrants and calculations assume a mild expansion in the number o f contributors5’. A comprehensive package52 o f This section draws heavily o n W o r l d Bank (2005b). This category does not include Government’s contributions (as employer) t o the end-of-service indemnity program for i t s contractual workers. 47 Defined benefits received by retirees are higher than what sustainability w o u l d entail given the current retirement age, l i f e expectancy and the contribution o f beneficiaries. The situation i s particularly severe for the military scheme, which contributed alone to 415 o f the public pension scheme deficit in 2004. 48 This corresponds to the present value o f pension promises (as the system i s based o n defined benefits) made t o current retirees and t o current contributors. 49 This figure also includes arrears accumulated by the Government vis-&vis NSSF health and family allowance programs. 50 The NSFF i s legally bound t o invest i t s finds into LBP-denominated instruments, w h i c h leaves little r o o m for risk diversification. 51 This assumption is n o t inconsistent with earlier discussions o n reducing the size o f the c i v i l and military administration, as a lower number o f contributors could be compensated with higher individual remunerations (see 45
46
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parametric changes in the civil service and military schemes could reduce the deficit to up to LBP594 billion in 2010 (or 1.4 percent o f GDP), against LBP1225 billion in the absence o f any reform. In other words, a comprehensive reform could help saving 1.4 percent o f GDP each year by 2010 (and up to 1.9 percent by 2050). Accordingly, the implicit debt o f the system would go down from 66 percent (without reform) to 30 percent (with reform) o f GDP in 2010. 36. But the Government could also consider closing public schemes to new entrants, as it would provide greater long-term developmental benefits, beyond fiscal aspects. Basically, the schemes for the civil service and the military would stop accepting new members. Those who would stay in the current scheme would face some gradual adjustments in the system, along the lines discussed in the previous paragraph. New civil servants and military personnel, on the other hand, would j o i n the reformed scheme for private-sector worker^.'^ Basically, Lebanon would converge, over time, to an integrated pension system. Although significantly improving the longterm fiscal stance, this operation would typically entail higher costs for the Government in the short run (compared with keeping the schemes open), as the latter would have to transfer to the NSSF the contributions o f new members and i t s contributions as employer. Besides, the contribution rate envisaged in the reformed private sector scheme i s twice higher than that in the civil and military schemes. Net fiscal gains, though, would remain substantial, as the closure o f existing pension schemes to new entrants combined with their reforms would still permit to save 1.2 percent o f GDP in 2010 (against 1.4 percent if schemes remain open to new entrants, see above). Furthermore, this reform would eliminate the implicit Government’s pension debt over the long run, reduce inequalities between public and private workers and facilitate labor mobility between public and private sectors (see also Chapter IV). Finally, from a political economy perspective acknowledging the difficulty to introduce all parametric changes, a transfer o f new entrants to the reformed private sector scheme would actually become less expensive from a fiscal point o f view. Transfers to Extra-Budgetary Entities
37. Transfers to extra-budgetary entities represented 2.9 percent of GDP and 14 percent of the Government’s primary expenditures in 2004.54They mostly comprise transfers to public autonomous agencies, public enterprises and private non-profit institution^^^ - 2.6 percent o f GDP, the remainder, 0.3 percent o f GDP, being constituted o f explicit subsidies to SMEs (soft loans for agricultural and export sectors, o i l price subsidies for the transport sector). Chapter IV). Contractual workers and employees o f public agencies and enterprises are n o t considered in these calculations as covered by NSSF. 52 Calculations envisage the elimination o f allowances and lump sums, the elimination o f the multiplier that applies t o the number o f years o f contribution in the military regime, the inclusion o f career wages in pension formula, the reduction in the accrual rate, the increase in the retirement age and contributions and penalties for early retirement. 53 The current end-of-service indemnity program imposes large and uncertain costs o n employers, which can reduce labor demand and encourage tax evasion. I t also restricts the mobility o f the labor force across f m s and contributes to the fragmentation o f the labor market. N o r does it provide adequate protection t o plan members. The draft l a w prepared in early 2005 t o transform the current program into a fully-funded defined contribution program permits to address these shortcomings and i s financially sustainable. This reform w o u l d nevertheless entail additional fiscal resources (in the range o f 1 percent o f GDP), but only after 2020. 54 Transfers to the NSSF and the Independent Municipal Fund (although b o t h extra-budgetary funds) are excluded f r o m this category and discussed in the other current expenditures section. 55 N o n Governmental Organizations (NGOs) in particular, through the M i n i s t r y o f Social Affairs, see Chapter 111.
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Out o f the former category, 1.8 percent goes to the electricity company (EdL) and water authorities to cover their operating losses and debt repayments. The final destination o f the remaining 0.8 percent i s difficult to trace, as it i s not explicitly reported in budget documents, but it i s believed that the bulk o f i t goes to support financially autonomous agencies, and cover their losses in some cases. Indeed, the ability o f SOEs and public autonomous agencies to build arrears (and the associated practice o f transfers from the Government to cover it) makes any serious expenditure planning unachievable (World Bank 2005a), and calls for the full inclusion of these extra-budgetary entities into the budget fi-amew~rk.’~
38. At the heart of any reform of public enterprises / autonomous agencies” lies the question of their ultimate role in the provision of public goods. Over the last years, the Government has legally or technically paved the way for the privatization o f some o f these agencies and enterprises, but two elements, inter alia, have probably prevented i t s realization so far. First, the role and responsibilities o f entities foreseen to be privatized have yet to be spelled out, in order to forge consensus on their destiny. Some o f them are indeed playing important roles in terms o f providing implicit subsidies or additional public revenue in the form o f monopolistic rents. Actually, some public enterprises are generating net revenue for the Government5*, but maybe at the expense o f greater competition and growth. A greater participation o f the private sector in these enterprisedagencies - up to privatization, would require an ex-ante distinction between “normal” private commercial operation and the set of instruments (tax and subsidies, regulation o f tariffs and standards, etc.) that would remain in the hands o f the Government to regulate markets and provide public goods. Second, some o f these entities need major overhaul (including audited accounts, investments, debt relief, etc.) and, primarily, a credible regulatory framework to eventually attract private investors’ interest, From fiscal and economic points of view, the reform of ElCctricit6 du Liban (EdL) i s 39. a clear priority. Government’s transfers to EdL are threefold: treasury advances (to cover operational losses), debt coverage and investments subsidies. Only a part o f theses transfers are structured as loans, and often thereafter converted to grants. The Government estimates that during the last decade, its yearly financial support to EdL was close to LBP5OO billion, not accounting for Government’s financial support o f capital expenditure. Transfers to EdL amounted to LBP492 billion in 2004 (1.5 percent o f GDP, not including Central Bank loans to EdL, which amounted to LBP250 million in 2004). Restoring EdL’s financial autonomy would hence definitely exert a strong impact on Government’s fiscal sustainability itself. Regained financial autonomy and reliability o f service delivery could also allow the reduction o f the cost o f power” for producers and consumers, to the benefit from greater economic activity. ~~
W o r l d Bank (2005a) also recommends that a n e w l a w o n public enterprises be prepared, with a v i e w t o strengthening governance processes and improving auditing and reporting practices. I t i s also highly recommended that the Government increases i t s oversight o f public enterprises and discontinue the practice o f converting loans t o rants without prior Parliamentary approval. There are currently 72 public enterprises or autonomous agencies (including the Central Bank, the NSSF, EdL, IDAL, Water authorities, CDR, councils o f the South and Displaced, etc.), some o f which have commercial activities. See W o r l d Bank (2005a) for the detailed list. 58 In 2004, revenue f r o m public institutions and government property amounted t o 4.4 percent o f GDP, out o f w h i c h 4.0 percent f r o m the sole Telecommunications sector. 59 By regional and international standards electricity tariffs are high in Lebanon (US$ 8.6Kwh). Furthermore the lack o f reliable service encourage consumers and producers t o use other sources o f supply (mainly diesel 56
’
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40. A combination of factors explains EdL’s precarious situation. EdL lacks a well articulated and comprehensive energy policy, as well as an appropriate Governance structure. The MoF’s quasi obligation to cover losses (to avoid blackouts) and growing subsidies inhibit EdL from adopting a sound financial discipline. EdL’s production costs are w e l l in excess o f what should be expected from a largely thermal based system. These high costs o f supply are exacerbated by the high rate o f commercial (illegal connections) and technical losses. The tariff structure i s un-adapted to the demand patterns, preventing EdL from fully exploiting i t s monopolistic position; EdL lacks staff in sufficient number and with adequate skills, in the face o f i t s inability to hire, as decided by the Government. While EdL’s number o f staff (2,250) seems to suggest that labor efficiency i s high, what i t masks i s the fact that EdL lacks sufficient number o f skilled staff allowing it to improve i t s efficiency and increase its collection rate. Furthermore, the fact that EdL’s financial accounts were not certified during the last three years, suggests that the operator lacks the management and financial staff capable o f implementing a sound and sustainable reporting system.
41. Reform efforts have been recently made, but the most challenging issues have not been tackled yet. Without implementing a comprehensive set o f corrective actions the quality o f electricity supply i s likely to deteriorate (as some plants get close to their end-of-life cycle6’), and the burden on the Government’s budget could further increase. The new electricity law from September 2002 only constitutes a first step in filling the lack o f a comprehensive strategy to restore EdL’s financial sustainability.61 Some credit can also be given to EdL for improving bill collection and reducing the number o f illegal connections in the recent years. I t has prepared for the introduction o f natural gas through the construction o f two combined cycle plants (and associated pipe lines for transmission to one o f them), and a contract to import natural gas from Syria has been signed.62 But while a switch to a largely gas based power system would help to reduce generation costs, i t would not be sufficient by i t s e l f to resolve the problems in the power sector. For example, some key transmission and substation projects designed to remove bottlenecks in the system and allow for import o f electricity have s t i l l not been completed. Necessary institutional reforms to improve governance o f the sector appear to have been assigned much lower priority.
generators), w h i c h are more expensive but more reliable. I t i s estimated that private generation amounts t o 20 percent o f the electricity production in Lebanon (World Bank 2004d). 6o Lebanon’s actual capacity for electricity generation i s at 1,400 MW, and will further decline unless some capacity investments are made. Lebanon’s current needs are estimated close to 2,000 MW, and could reach 2,500 M W in the medium t e r m if industrials were t o renounce t o generate their own electricity. 61 On September 5, 2002, the Parliament approved L a w # 462 w h i c h outlines the w a y the electricity sector i s t o be governed and provides the basis for introducing private sector participation. However, the l a w i s silent o n a timeframe for implementation, o n h o w many corporatized entities should be created for generation and distribution. There is also n o provision requiring the private o r public entities in the sector t o provide electricity at the lowest possible economic cost in an environmentally sustainable w a y o r to introduce market based incentives o r competition. N o substantive preparatory w o r k has been done so far t o implement the industry structure envisaged under the law. 62 Importing gas f r o m Syria will not solve a l l problems: f i s t , because there is currently n o pipe line between Syria and the southern plant (Zahrani); second because Syria’s supply capacities o f natural gas are probably insufficient to meet Lebanon’s needs.
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42. The Government and EdL have recognized that there are no quick fixes to the problems of the power sector. They have developed a roadmap which set a comprehensive program in motion, which could result in reliable electricity supply at reasonable cost and power utilities which can operate without government financial support. Provided that an appropriate Governance structure can be put in place, introduction o f private sector participation could be an appropriate tool to help achieving the Government’s objectives. However, i t will take several years to implement such a program. The comprehensive approach proposed by the roadmap has the following key elements: (i) build capacity to implement reforms (ii) reduce the cost o f supply and improve systems reliability; (iii)prepare and initiate the corporatization and commercialization process; (iv) prepare an interim management contract (for about 2 to 3 years; (v) design a long t e r m strategy, including options for the optimal industry structure and further private sector participation and an appropriate regulatory framework; and (vi) initiate a public relations campaign. 43. Any comprehensive strategy will also entail up-front costs. EdL can save some money o n two fronts: by reducing generation costs and technical and commercial losses. At current gas and o i l prices, some LBP300 billion worth o f generation costs could be saved every year with the two main plants (Bedawwi and Zahrani) switching to natural gas from 2007 onwards. Around LBP225 billion could also be saved by replacing two other fuel plants (Jiyyeh and Zouk) coming to the end o f their l i f e with natural gas plants at the 2010 horizon. And another LBP60 billion could roughly be saved annually by halving technical/commercial losses63. All in all, this full package of savings could basically eliminate EdL’s operational losses in a five-year time.64But achieving these transformations will require physical investments in the generation, transmission and distribution sectors in the order o f US$1.15 billion. Part o f these investments could be financed with soft loans from donors, while others could take the form o f B O T and D B O T contracts, In the meantime, some significant savings could be made in the procurement o f o i l and diesel, by revising bidding / tendering practices and setting less stringent standards. Initial steps taken by the Ministry o f Energy and Water in these directions could already permit to save US$60 million in 2005. Other Current Expenditures
44. This category covers transfers to the Social Security, Hospitals and Municipalities (2.5 percent of GDP and 13 percent of primary expenditures) and Government’s operational expenditures (0.7 percent of GDP and 3 percent of primary expenditures). The first set o f expenditures is largely under-funded, and has represented a major source o f the 63 Twenty-three percent o f the electricity produced i s not billed o r collected (commercial losses), while another 15 percent i s lost during transmission (technical losses). The Government envisages bringing d o w n these two ratios t o 10 percent, by rehabilitating the transmission and distribution networks and placing intermediate and end-use meters t o identify the source o f commercial losses. 64 These calculations do not include the repayment o f the part o f EdL’s outstanding debt, which has not been consolidated with that government debt, nor in reverse the settlement o f Government and public entities arrears with EdL (unpaid bills). In the absence o f consolidated accounts for the whole public sector (Central Government, municipalities, public enterprises, autonomous agencies) and for EdL in particular, i t i s difficult to estimate these amounts. These calculations do n o t include either pension liabilities accumulated by EdL vis-a-vis i t s employees. As the latter are c i v i l servants, such liabilities are part o f the overall government implicit debt discussed in the section o n pensions.
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Government’s built-up arrears (including LBP867 billion vis-&-vis the NSFF, LBP139 billion vis-&-vis the Hospitals, and LBP800 billion for expropriations by end-2004). As such, i t i s difficult to envisage a compression o f government spending in these areas in the short run. The regularization o f flows should take place rapidly while the stock o f arrears should at least been converted into official debt (see below). This does not, however, prevent the Government from starting to re-evaluate its overall social protection strategy along the lines discussed in Chapter 111. 45. Operational expenditures could be rationalized through a revision o f procurement rules and practices. Ministries and public agencies have to abide by an antiquated Public Procurement L a w and procedures dating back to 1959 and 1963.65 A revised draft public procurement law was prepared by the Government but was never passed by the Parliament. If approved and implemented, i t would greatly enhance the efficiency and transparency o f public procurement procedures and would allow donors to rely increasingly on national public procurement systems. N o t only would this help to rationalize operational expenditures, but it would also accelerate disbursement on donors’ projects - see below. Reaping all the benefits o f more transparent procurement rules would nevertheless be conditioned on greater competition in the supply o f goods and services consumed by the Government (see Chapter I). Capital Expenditures
46. Consolidated Public Investment expenditures amount to approximately 3 percent o f GDP and 15 percent o f primary expenditures.66Out o f the total, broadly one fourth is financed by donors, in the form o f subsidized loans, while the rest i s domestically funded. Typically, the cost of domestically financed capital expenditure i s higher than that o f foreignfinanced, as interest rates on the domestic public debt are roughly double than those incurred on donors loans. Besides, the debt profile i s different, with longer maturities for donors’ loans.
According t o these, public procurement i s based o n a centralized system managed by the Department o f Tenders (DOT) o f the Central Inspection Board (CIB). All procurement i s t o be listed in the annual General Schedule, w h i c h i s finalized after the State Budget i s approved. The legislation puts DOT in charge o f carrying out the tendering for procurement o f works and goods. Bid evaluation i s mandated t o the Central Committee for Tenders, whose members are approved by the CIB. This system worked at a time, when procurement o f goods consisted o f a limited number o f standard goods and types o f public works, and could therefore b e managed efficiently by a core o f qualified officers in DOT. The establishment o f the Council for Development and Reconstruction (CDR) in 1977 specified the provisions regarding the financial and accounting transactions, including procurement procedures, applicable to CDR. Since then and for a number o f years, CDR has taken over the management o f a significant proportion o f the public procurement. And more recently, in the absence o f sufficient staff in the DOT, and as a result o f the diversity and specificity in the scope o f goods, works and services t o b e procured, ministries have taken in some cases advantage o f exceptions provided by the Cabinet t o manage their procurement. The current situation is, therefore, legally confusing and hardly sustainable. The previous legislation has become obsolete and i t s provisions n o longer satisfy the requirements o f a modern, transparent and efficient public procurement system. 66 On top o f public investment figures reported in the budget one should add foreign-financed (through loans) investment expenditures managed by the CDR. Though, the latter include some CDR contracts (up t o US$lOO m i l l i o n per year) with private enterprises w h i c h deliver regular services, and as such, should not b e counted as capital expenditures. 65
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47. The economy and Government’s budget are not receiving the full benefits o f the capital expenditures that have been made. In spite o f US$8.5 billion disbursed between 1992 and 2003, the number o f projects that have not yet been completed i s large6’. The major investments made in the power and telecommunications sectors, close to a quarter o f total capital expenditures since 1992, are not yielding the benefits that should be expected: as discussed previously the electricity company i s not financially autonomous, and power and communications costs are among the highest in the region. The sizable investments in roads are not being adequately maintained, and the physical investments in other sectors, particularly in the social sectors, have not been complemented with institutional development and policy reforms, Cost recovery in most sectors i s limited. 48. Nevertheless, in the face of future needs, there i s little scope to further reduce public investment expenditure. Maintenance and rehabilitation expenditures needed over the next five years are estimated by C D R (CDR, 2004) at a minimum o f US$1.7 billion (or 1.4 percent o f GDP every year, under the assumption o f a 5 percent annual nominal GDP growth), not including the replacement o f the two power plants coming to the end o f their life (see above) and estimated at 0.7 percent o f GDP. Hence, the sole maintenance o f the public capital stock (not considering natural resources), including a complete overhaul o f the power sector would broadly cost 2.3 percent o f GDP every year (over the period 2005-9)68, and any new investment project should be financed on top o f this figure. With broadly 3 percent o f GDP devoted to public investments, Lebanon i s far below successful comparator countries69, and further reducing this figure would most likely affect negatively economic output. Recent literature indeed points to the utmost need to maintain a minimum set o f public infrastructure to enable growth (Arestoff and Hurlin, 2005). 49. On the other hand, the total amount of investment plans under preparation most likely exceeds what Lebanon can financially afford in the next five years. A total o f US$5.2 billion worth o f public investment projects are currently under preparation or have already been committed by the Government, in the form o f capital budget carryovers, outstanding payment orders, ongoing C D R contracts, and the balance o f program laws (multi-years budgets for which no budget appropriations have been made - although part o f which may have already been contractually committed). This would represent annually an outlay o f 4.1 percent o f GDP o n top o f the 2.3 percent o f GDP needed for maintenance, which would greatly undermine Lebanon’s possibility to contain i t s primary expenditures in the near future. In all cases, there i s a need to reduce the overall envelope o f planned investments and reform public investment planning procedures (see Chapter IV). 50. From a financing perspective, reducing the cost of public investment depends on raising the share of donors’ funding, as interest rates on donors’ loans are cheaper than that 67 F o r instance, an estimated US$1.2 b i l l i o n h a d been spent by end-2003 o n foreign funded projects that h a d not yet been completed (Source: W o r l d Bank staff calculations based o n CDR data). Using a completely different methodology (based o n the estimate o f the current public capital stock and the assumption o f a 3.3 percent depreciation rate), the Ministry o f Economy and Trade concludes that the depreciation of public infrastructures represented 2.4 percent o f GDP in 2002 (MoET, 2005). 69 Tunisian and Jordanian public capital expenditures have been turning around 7 percent o f GDP in the recent years. OECD countries used t o invest about 5 percent o f their G D P in public infrastructures until the mid-70s (Arestoff and Hurlin, 2005).
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financing the public deficit. Raising this share depends first on utilizing more existing loans signed with donors. By end-2003, up to US$1.8 billion worth o f future projects had been committed by donors for the next years, which would require counterpart funds in the range o f US$400 to US$500 million.70 Delays on these funds are costly, as they entail commitment fees for donors - typically around 0.5 percent o f the unused funds. Raising the share o f foreignfinanced investment i s contingent on a complete re-examination o f the current portfolio o f planned investments (both domestic and foreign-financed projects). I t i s also contingent on reforming C D R institutional responsibilities, procurement laws, parliament ratification procedures and settling arrears on expropriations which all reduce Lebanon’s absorptive capacity o f foreign funds for investments, as underlined in the World Bank’s Country Portfolio Performance Review (CPPR) undertaken in late 2002. But even under optimistic assumptions, the potential savings stemming from a greater use o f foreign funds would remain modest in comparison to the decision made regarding the overall envelope o f public investments. Indeed, moving to a situation where h a l f o f public investment projects would be financed by donors (US$1.8 billion over five years if public investment remains at 3 percent o f GDP) would only permit to save up to 0.05 percent o f GDP every year. The main financial benefit would actually lie in the fact that donors’ foreign loans have longer maturities (including grace periods), which could permit to reduce debt service in the short run and mitigate roll-over risks as well. O n the other hand, greater reliance on foreign funds from donors would ceteris paribus increase the share o f the public debt denominated in foreign currency and related vulnerabilities (see B o x 1 on debt management). Probably more important in this process are the prerequisites which would permit to the use in a sustainable manner donors’ funds more effectively: C D R reform, procurement law, parliament ratification procedures, public investment planning, capital and current budget consolidation. All these would reinforce the capacity o f the Government o f Lebanon to appraise the macro and micro economic relevance o f investment projects. Some o f these issues are discussed in more details in Chapter IV. Possible Medium Term Expenditure Outlooks 51. There i s significant scope to rationalize primary public spending over the next five years. The combination o f the various reforms discussed in the previous paragraphs could permit significant fiscal space for adjustment, while laying the ground for a more effective provision o f public goods. The table below illustrates in a prospective scenario the gains that could result from (i) the reform o f civil and military pension schemes, (ii) the rationalization o f current expenditures, (iii) the overhaul o f the power sector (leading to the financial autonomy o f EdL by 2010) and (iv) greater absorptive capacity o f foreign loans. Reform o f the civil service would be neutral fiscally @e., the wage bill would continue to grow at 3.3 percent every year, per its growth rate 1997-2004), as the reduction o f the public labor force through attrition would be used to train government employees and develop a more effective incentives’ This scenario i s compared to another one (“status quo”) where the Government would maintain per Preliminary estimates for end-2004 put the sum o f projects that have been committed by donors for the next years at approximately US$1.5 billion. ” Replacing only two out o f three pubic workers retiring in the next ten years, halving the number o f contractual workers and privatizing the public electricity company in the next five years while maintaining the current nominal growth in wage expenditure w o u l d permit to spend 35 percent more by workers in 2010 than in 2004, in the f o r m o f training or wage increases. ’O
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capita primary public spending in real terms (Le., allowing for a 2.5 percent annual increase in nominal terms, per inflation and population growth rates between 1997 and 2004), except for pensions, which would grow up by 7.1 percent annually in the absence o f reforms, and the wage bill, which would go up by 2.1 percent as the Government would continue to impose wage and hiring freeze, hence saving through attrition.72 By end 2010, the difference in total primary spending between the two scenarios could amount to approximately LBP1,OOO billion. Comparing the situation by end-2010 with that o f end-2004, a full package o f reforms would permit to contain annual growth in nominal expenditure at 1.8 percent over the period, against 4.0 percent in the absence o f reforms. Both scenarios assume that the Government stops accumulating new arrears vis-a-vis its employees and the NSSF from 2005 onwards - see below. Table 4 below reports the scenarios under the assumption o f a 5 percent annual increase in nominal GDP. Under such an assumption, expenditure reform could contribute to a 3.5 percentage point increase in the primary surplus over GDP.
72 Wages would continue to go up by 3.3 percent annually the result o f promotions, but the wage bill would increase less rapidly, as one-third of the employees retiring would not be replaced.
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Table 4. Prospective Public Expenditure Outlooks (as a percentage o f GDP)
Status Quo Scenario Wage, salaries and compensations a/ Pensions b/ Transfers to extra-budgetary entities c/ Other current expenditures d/ Capital expenditures e/ Other primary expenditures e/ Total primary expenditures Reform Scenario Wage, salaries and compensations f/ Pensions g/ Transfers to extra-budgetary entities h/ Other current expenditures i/ Capital expenditures j/ Other primary expenditures kl
Total primary expenditures
2004
2005
2006
2007
2008
2009
2010
7.0 2.5 2.9 3.2 3.2 1.9
7.5 2.6 2.9 3.4 3.1 1.8
7.2 2.6 2.8 3.3 3.1 1.8
7.0 2.7 2.8 3.3 3.0 1.7
6.8 2.7 2.8 3.2 2.9 1.7
6.7 2.8 2.8 3.1 2.8 I.7
6.5 2.8 2.8 3.0 2.8 1.6
20.6
21.2
20.9
20.5
20.2
19.8
19.5
7.0 2.5 2.9 3.2 3.2 1.9
7.5 2.3 2.5 3.4 3.2 1.8
7.4 2.1 2.2 3.3 3.2 1.8
7.3 2.0 1.9 3.1 3.2 1.7
7.2 1.9 1.6 3.0 3.2 1.6
7.1 1.7 1.4 2.9 3.2 1.5
6.9 1.6 1.2 2.7 3.2 1.5
20.6
20.8
20.0
19.2
18.5
17.8
17.1
Source: World Bank staff calculations. Nominal GDP i s assumed to grow by 5 percent annually. Notes: a/ the wage bill i s assumed to grow at 2.1 percent annually (see main text). As o f 2005, the Government stops accumulating new arrears vis-a-vis its employees; b/ the deficit in civil and military pension schemes goes up to LBP1225 billion by end 2010 (see main text); c/ transfers to EdL go up to LBP700 billion by end 2010. Other transfers go up by 2.5 percent annually (Le. stay constant in real per capita terms, per the inflation and demographic rates 1997-2004 - see main text); d/ grows up by 2.5 percent annually. As o f 2005, the government stops accumulating new arrears vis-a-vis the NSSF; e/ grows up by 2.5 percent annually; f/ the wage b i l l i s assumed to grow at 3.3 percent annually. As o f 2005, the Government stops accumulating new arrears vis-a-vis i t s employees; g/ the deficit in civil and military pension schemes goes down to LBP704 billion by end 2010 (see main text); h/ transfers to EdL are eliminated by end 2010 (see main text). Other transfers grow up b y 2.5 percent annually; i / goes up b y 0.3 percent annually, the result o f a 10 percent drop in prices by 2010 (the result o f improved procurement practices and reduced corruption) before inflation and population growth. As o f 2005, the Government stops accumulating new arrears vis-a-vis the NSSF; j i goes up by 5 percent annually; k/ goes up by 0.3 percent annually, the result o f a 10 percent drop in prices by 2010 before inflation and population growth.
52. Estimated Government’s stock o f arrears, at LBP3425 billion (10 percent o f GDP) by year-end 2004, should be settled in the next years. The recent computation o f arrears by the Ministry o f Finance, although tentative and yet un-audited, reveals sizeable contingent liabilities: various arrears (delays o f payment) have been accumulated over the recent years, mainly vis-& vis extra budgetary funds (NSSF and the Institute o f the Guarantee o f Deposits), private operators (hospitals, contractors), households (through the expropriation o f their land) and public employees (for which a wage increase decision was adopted by the Parliament, Laws # 716, 717, 718 on November 5, 1998 but never applied since, as confirmed by various tribunal decisions). Building-up arrears has various consequences: poorer fiscal transparency, higher tariffs for private services73, weaker social safety nets, and greater difficulties to implement investment
73 I t is l i k e l y that private operators ask for premiums when dealing with the Government, t o cover the risk o f delays in payments.
39
projects74. In this respect, not accumulating new arrears i s a first priority, which will nevertheless add about one percentage point o f GDP to primary spending, as reflected in expenditure outlooks above.75Addressing the stock though, i s a much more difficult undertaking, which could consist o f transforming some o f the arrears into formal debt and the remainder being repaid progressively over years. The calculations above assume that the full stock o f arrears (at end 2004) is converted into formal debt. Table 5. Government’s Arrears as o f end-2004 (LBP Billion) NSSF and the Institute of Guarantee of Deposits Hospitals Expropriations Wages others Source: MoF, June 2005.
1,062 139 800 1,304 119
74 As a large number o f public investment projects (including donors financed projects) are stalled before cases $ F a v e n t s o f arrears) are legally settled. Some LBPlOO b i l l i o n annually t o the NSSF and another LBP270 b i l l i o n t o public employees, or 1.1 percent o f GDP in 2004.
40
Chapter 111. Raising the Efficiency of Social Spending and Strengthening Safety Nets
53. Raising the efficiency of social sector spending i s critical to support the fiscal adjustment. A s underlined in Chapter I,enhanced social sector service delivery and protection i s a must in Lebanon, given the short run negative impact fiscal consolidation might have on employment. In addition, the demand for public social services i s expected to increase with fiscal contraction (and households’ reduced ability to afford private services, health and education). Yet, limited fiscal resources and high levels o f inefficiencies imply that the first order o f priority in the social sectors i s to address the inefficiencies within and raise the productivity o f public social sector expenditure rather than increase their resource envelope. A reduction in social spending via employment benefits to civil servants (including the military, judicial and security personnel) i s one such priority. A second is the more efficient regulation o f private provision and coordination between the private and public sectors in the social arena.
54. At the same time, safety nets need to be strengthened. Among others, risks o f financial crises cannot be underestimated in Lebanon given the high public debt level and banks’ exposure to sovereign risk. Fiscal consolidation would typically mitigate such vulnerabilities. But o n the road to fiscal sustainability, Lebanon will remain greatly vulnerable to confidence shocks, including i t s greatly volatile regional and domestic political environment. Recent international experiences tell us how deep financial crises can hurt social fabrics and create irreversible damage to human capital (in the form o f lower children food-intake or higher school drop-outs for instance), and underline the need to be prepared in the event. More generally, i t i s believed that Lebanon’s level and characteristics o f social protection are not adapted to the developmental needs o f a middle-income small open economy, and could actually be an impediment to growth, Dismissed as ineffective, expensive and even detrimental to growth, i t is now increasingly understood that assisting individuals, households and communities in dealing with diverse risks i s needed for sustained economic and social development (World Bank, 2003b). Hence the need to review what could be done in the short and long run to insure adequate protection against major shocks for the Lebanese population. 55. Overall, Lebanon needs to define a long-term social strategy and plan for it. A strategic vision for overall social and human development i s missing in Lebanon. There i s an absence o f a comprehensive and integrated social policy and agreed upon sector strategies by line ministries. A national commission for strategy/policy/coordination o f social policy is needed to lead the effort. 56. This chapter reviews existing social sectors spending in Lebanon, and explores ways to improve the efficiency and equity o f social sector services with the view to: (a) better support human capital development during the ordinary course o f Lebanon’s economic development; and (b) prevent human capital deterioration during an economic crisis. The sectors covered by this chapter are primarily those o f the Ministry o f Education (MoE), Ministry o f Health (MoH), and to a lesser extent the Ministry o f Social Affairs (MoSA), given i t s relatively small size.76 The 76 There are other agencies and sectors relevant to the present study (for example, pensions, labor and broader c i v i l service issues, pricing o f utilities-such as water or electricity, provision o f infrastructure - such as housing and roads, agricultural and other subsidies, support to SMEs o r microfmance and so on). Some o f them (for example,
41
report utilizes administrative data and published research and i s based o n a review o f previous assessments o f these three sectors, as well as, information collected during selected field visits. I t does not aim at re-evaluating in depth the characteristics and efficiency o f the three social sectors nor the various programs supported by the social ministries, but rather at putting social sector service delivery and protection into a macro-economic, budgetary and risk perspective. Social Sector Expenditure and Outcomes
57. Social sector spending in Lebanon i s high, in nominal terms and as a proportion of GDP, with more than 70 percent o f that spending coming from the private sector. The sum o f public and private social spending stood at approximately 21 percent o f GDP in 2004, out o f which 15 percent was supplied by the private sector (Table 6). The remainder, which constitutes public social expenditures, stood at 6 percent of GDP. This i s l o w compared to other MENA countries77, but it represents a high percentage o f public primary expenditures: in 2004, social public spending (as defined by the operations o f MoE, M o H and MoSA) represented 26 percent o f primary expenditures. If expenditures channeled through other agencies are included (finctional expenditures), social public spending amounts to 38 percent o f primary expenditures. Furthermore, accounting for public pensions and end-of-service indemnities would put total social expenditures at 24 percent o f GDP, and public social expenditures at more than half of government primary expenditures in 2004.
pensions) are covered in parallel reviews from the W o r l d Bank (see Chapter 11) while others have been addressed in various ways in the past and will not be directly the focus o f the present study. ” Public social expenditures (excluding pensions) represent 9 percent o f G D P in Morocco, 10 percent in Egypt, 12 percent in Iran, 14 percent in Jordan and Tunisia, and 15 percent in Algeria.
42
Table 6. Public and Private Social Expenditures (LBP Billion and as percentage o f GDP) 1998*
2004
2004 as percentage of GDP
Administrative Expenditures (A) Education Health Social Affairs Functional Expenditures’ (B) Education
Health Social Affairs Total Public Expenditures (A+B) Education Health Social Affairs Private Expenditures (C) Education Health Social Affairs Total Public and Private (A+B+C) Education Health Social Affairs
1,157 76 1 291 105 570 358 183 29 1,726 1,120 473 134 4,186 1,760 2,427 n.a. 5,913 2,880 2,900 134
1,318 864 345 109 600 365 216 19 1,918 1,229 561 128 4,829 2,030 2,799 n.a. 6,747 3,259 3,360 128
4.0% 2.6% 1.1% 0.3% 1.8% 1.1% 0.7% 0.1 % 5.8% 3.7% 1.7% 0.4% 14.7% 6.2% 8.5% ma. 20.6% 9.9% 10.2% 0.4%
Primary spending 25.9% 17.0% 6.8% 2.1 % 11.8% 7.2% 4.3% 0.4% 37.8% 24.2% 11.O% 2.5%
Source: World Bank staff calculations. Public exDenditures are comuuted based on Ministrv o f Finance Budnets 1998 and 2004. Private expenditures estimates are extrapolated from World Bank’s 1997 PER for education and national health accounts from 1999. * Figures for 1998 are expressed in 2004 prices, to allow a comparison in real terms with 2004. Notes: 1/ Functional Expenditures are additional public social spending channeled not through the responsible ministry but through other public entities such as ministries o f Interior, Defense, Agriculture, Information, Coops, etc. 2/ Private expenditure b y NGOs and others on social sectors i s known to be sizable but n o reliable estimates exist. 3/ WHO data from the NHA shows public health expenditures as percentage o f GDP to be 3.4 percent in 2002 Y
58. Total social sector spending i s not commensurate to outcomes. Though commendable in many respects, health and education indicators are commensurate neither with the overall (private plus public) spending in these sectors nor with Lebanon’s stage o f development. International comparison o f health outcomes, relative to per capita expenditures, suggests that returns to health spending are l o w in Lebanon. Per capita health spending in Lebanon, at approximately US$500 per year, i s four times higher than that in Jordan or Tunisia. Yet, infant mortality i s the same, maternity death much higher, and life expectancy only slightly better in Lebanon (Table 7). A similar picture emerges for education. At US$4,000 GNI per capita in
2002, Lebanon had a lower primary completion rate than Tunisia, Jordan, Iran, Algeria, and Egypt, all countries with significant lower GNI per capita (Table 8). The primary completion rate in Lebanon has also not shown any improvement between 1995/6 and 2003/4. Another international benchmark o f the performance o f Lebanon’s education system i s the 2003 Trends in International Mathematics and Science Study (TIMSS) scores. TIMSS assesses student learning in 8th grade in Mathematics and Science. As presented in Table 8, the national performance o f 8th grade Lebanese students was 393 in science and 433 in mathematics. Both these scores are below the international averages o f 474 and 467, respectively, and in science, Lebanon was outperformed by all participating MENA countries (except Saudi Arabia). 43
Furthermore, when adjusted for level o f income Lebanon performs w e l l below expectations (Figure 2).
Table 7. Health outcomes and per capita spending, selected MENA Countries Infant Mortality Maternity death Life Expectancy Per Capita Health Rates per 1,000 per 100,000 live at Birth Spending (US$) live birth (2002) births (1995) (2002) (2002) Oman 12 120 74.1 1138 UAE 8 30 75.4 752 Kuwait 10 25 76.9 630 Lebanon 26 130 70.8 499 Bahrain 7 38 73.3 430 Saudi Arabia 21 23 73.1 352 Jordan 25 41 72 134 Tunisia 24 70 72.7 118 Iran 35 130 69.3 96 Algeria 38 150 70.7 62 Morocco 39 390 68.4 56 23 200 70.3 42 Syria Egypt 35 170 68.9 38 Yemen 78 850 57.4 20 Source: World Bank staff calculations. Note: Data are for 2002 or last year available.
Table 8. Education indicators and GNI per capita, selected MENA Countries
Upper Middle Income Lebanon Tunisia Jordan Iran, Islamic Rep. Algeria Egypt, Arab Rep. Morocco Syrian Arab Republic Yemen, Rep.
Repeaters TIMSS TIMSS Primary as % of total Science Mathematics Completion enrolled, Scores, 2003 Scores, Rate (%) primary (1) 2003 (1)
GNlper capita (US$) (2002)
Adult literacy rate (%)
5,160 3,900 1,990 1,760 1,740
91-50 86.50 73.20 90.90 77.10
93.40 88.00 98.80 98.20 107.30
5.20 9.70 9.80 0.50 4.30
474 (2) 393 404 475 453
467 (2) 433 410 424 41 1
1,720 1,470 1,170
68.90 56.10 50.70
95.50 89.30 67.50
116 0 5.10 13.70
421 394
406 384
1,090 490
82.90 49.00
87.50 65.00
6.80 4.30
Sources: WDI, EdStats, TIMSS, World Bank staff calculations. Notes: Note: Data are for 2002 or last year available. I!Trends in International Mathematics and Science Study (TIMSS) sth grade scores. 2/ International Average (different groups o f countries than “Upper Middle Income” classification).
44
Figure 2. Performance in Science (Sth Grade) By GDP Per Capita Performance in Science (8th Grade) By GDP Per Capita 600
~~~~
Rz 33.9%
~
SOP*
EST-
550
*
KOR HUN
vR
HKQ NLD USA BEL
500
NOR
ITA
In
450 BUR
01
2
400
Lebanon
MOR*
U
PHL
5
I 350
CYP
BWA
300 QHA
250
200
ZAF
0
5000
10000
20000
15000
25000
30000
35000
40000
GDP Per Caplta PPP lnternl. 0
ource: World Bank staff calculations based on TIMMS and World Development Indicators.
59. Nor i s public spending commensurate to outcomes. Figures discussed so far compare different education and health attainment indicators across countries, controlling for per capita GDP. Though, these comparisons could give a biased picture o f Lebanon's public expenditure efficiency, for two reasons: first because there is a well known positive association between social spending and GDP7'; second because social spending in Lebanon i s mostly private, as described in Table 6. But this i s actually not the case. Controlling for these two factors, Herrera and Pang (2005) estimate that input efficiency - excess (public) input for a given level o f (public and private) output i s o f the order o f 79-87 percent for education7' and 71-75 percent for health". In other words, Lebanon uses at least 25 percent more inputs (public spending) to produce the same health outcomes than best practices countries*' (and at least 13 percent more inputs for education). And this does not account for the fact that Lebanon's share o f private spending in total social spending (at least for health - but also probably for education) i s much higher than in most o f the countries considered in this study (more than 180, including industrialized countries)82.
" This positive association between expenditure and the level o f economic development stems f r o m the fact that wages tend t o be higher in richer countries, reflecting the higher marginal productivity o f labor. This in turn tends t o increase the cost o f labor-intensive activities such as health and education. 19 N e t primary and secondary school enrolment. L i f e and L i f e disability-adjusted expectancy at birth and immunization rates (DPT and measles). Korea, Malaysia, Thailand, Trinidad and Tobago, Oman, United Arab Emirates, Mauritius, Kuwait, Chile. 82 Private spending o n health over GDP averages 2.3 percent for the 187 countries sampled - to b e compared with 10.2 percent in Lebanon. There i s n o similar figure for private education. Public education spending averages 4.5 percent o f G D P for 166 countries sampled.
''
45
60. Social sectors in Lebanon include some state-of-the-art health and education facilities, which have little impact on the poor. Lebanon has specialized in state-of-the-art health and education services, such as plastic surgery for instance, which i s targeted to an international and rich Lebanese customer base. These activities have flourished in recent years, and n o w represent 5 to 10 percent o f GDP. Much o f these services, however, are inaccessible to a large segment o f the population and serve to hrther deepen the duality o f the Lebanese social sector system.
61. High price levels are one of the explanations for the low value for money of social spending in Lebanon. Price levels are high in Lebanon, maybe the result o f strong Dutch and much above what disease effects stemming from massive capital inflows (see Chapter I), should be expected from i t s developmental stage (as measured in nominal per capita GNI). When converted into purchasing power parity (PPP) terms, one dollar in Lebanon i s worth h a l f o f what it i s in Jordan (Table 9). Furthermore, these observed differences in national price levels most likely understate the actual differences in non-tradable sectors, to which most social services are a part of, Thus, while Lebanon appears to spend on health four times more per capita than Tunisia, in PPP terms i t spends only 60 percent more. Table 9. Price levels in comparator countries in 2003 Lebanon Upper Middle income Uruguay Jordan Malaysia Turkey Latvia Mauritius Egypt Tunisia Source: World Development Indicators.
GNI per capita (US$) 4,040 5,340 3,790 1,850 3,780 2,790 4,070 4,090 1,390 2,240
GNI per capita (PPP) 4,840 9,900 7,980 4,290 8,940 6,690 10,130 11,260 3,940 6,840
Domestic Prices Index 0.83 0.54 0.47 0.43 0.42 0.42 0.40 0.36 0.35 0.33
Social Sector Efficiency
62. Available indicators suggest low internal efficiency of Lebanon’s public social expenditures. In education for example, Lebanon has one o f the lowest ratio o f pupils to teachers at the primary level (17: 1) in the region and an extremely l o w ratio at the secondary level (8: 1) (Table 10). This is a reflection o f the highly politicized process o f teacher recruitment and placement, as well as, the lack o f planning in school placement^.'^ I t also signals a high share o f personnel expenditures relative to other education expenditures. While there are no international norms for the “right” pupil to teacher ratio, it i s generally considered that such ratios can go up to 40:l in primary education and 2 5 : l in secondary education without compromising the quality o f education. Furthermore, empirically, class size i s not found to affect student performance. Therefore, increasing the pupil to teacher ratio in Lebanon would make the 83 In 200314, there were 348,144 students and 42,352 teachers in the public sector, excluding university, reflecting a pupil - teacher ratio o f 9. In 6 o f the 26 governorates, the pupil-teacher ratio was b e l o w 5.
46
system more efficient and cost-effective without impacting school quality. This would eventually require a reduction in the number o f teachers, given the slow demographic growth rate in Lebanon (estimated at 1.3 percent, Kasparian, 2003). Table 10. Pupil to Teacher Ratios (2002)
Primary education 17.0 11.8 20.6 21 .I 22.5 24.0 28.2 21.9 27.5 24.4
Lebanon Saudi Arabia Jordan Oman Egypt, Arab Rep. Syrian Arab Republic Morocco Tunisia Algeria Iran, Islamic Rep.
Source: World Development Indicators.
Secondary education 7.6 11.7 14.3 16.5 17.4 17.9 18.1 20.1 20.8 28.9
In health, inefficiencies are demonstrated through the l o w occupancy rate (56 percent) in public hospitals (Figure 3). Other evidences o f inefficiency are the relatively high levels o f public (and NSSF) expenditures on hospital-based curative care versus more basic out-patient care (Figure 4). The M o H spends almost 70 percent o f its budget o n inpatient care while devoting only less than 10 percent o f its resources to out-patient type services, a pattern mirrored, albeit to a lesser degree by the NSSF. In Jordan, by contrast, M o H expenditures on hospital services constitute about 50 percent o f overall expenditures.
Figure 3. Hospital Occupancy Rates 90%
80%
1- 80%
60% 50% 40% 30% 20% 10% 70%
0%
80% 72%
68%
65%
65%
64%
60% 58%
56% 54%
53%
52% 45% 37%
-I
47
-
1
Illtll
48
I
Governorate Beirut Mount Lebanon North Lebanon South Lebanon Bekaa Nabatieh , All Lebanon
Population with low satisfaction of basic needs (poor) Share in Governorate Total 19.2 78,221 26.0 297,819 48.9 327,928 39.0 110,392 43.8 175,152 51.4 105,581 35.2 1,095,363
Beneficiaries of social assistance Total Share in poor 8,211 10.5 16,608 5.6 5,555 1.7 6,621 6.0 4,934 2.8 1,832 1.7 43,761 4.0
64. The internal efficiency o f public social spending i s hampered by a severe misallocation o f resources. About 15 percents4 o f public social spending (excluding pensions) takes the form o f benefits to public sector employees (some o f which are increasing with salaries). Beyond i t s negative impact on labor market efficiency (see Chapter IV), this spending i s not targeted towards the poorest segments o f the population and entails large opportunity costs. Indeed, if these benefits were directed at improving the supply side o f social services (for example, better quality schools and health services nationally), they would result in greater benefits for all Lebanese, especially the poor. 65. The lack of coordination between providers also generates important waste. From a developmental perspective, it i s important that clear policy objectives and targets guide budgetary allocations, and, in turn, the budget itself generates the adequate information to insure a proper funding o f key policy objectives. This review o f public expenditures could not identify neither clear policy objectives nor how budgetary allocations relate to them. This issue i s not specific to social sectors (as i s neither the quality o f the public administration or governance), and should be dealt with through civil service, public administration and budget process reforms (See Chapter IV). Yet, i t implies at the sector level an overlapping o f public providers in the provision o f heath, education and social services, hence redundant or excessive capacities. The insufficient coordinations5 with the private sector, in the face o f lacking information on the nature and extent o f services provided and absence o f sector and nation-wide objectives (which could help both public and private operators to plan future needs and investment opportunities), i s also a great source o f potential duplication and waste o f national resources. 66. A major impediment to understanding social expenditure and being able to make policy based on evidence i s the absence o f reliable and periodic data on: (i) the incidence o f public social spending (targeting, coverage, cost effectiveness) and (ii) the nature and impact o f private social spending which renders difficult the analysis o f their overall social utility. B o x 2 shows that much needs to be done with regards to health, education and poverty/social statistics.
84 As measured by the sum o f family allowances and advances for education and health granted to public sector employees, some L B P 288 b i l l i o n in the Budget L a w 2004. 85 W o r t h noticing however that the Ministry o f Health made important progresses in that regard in the recent years by putting in place an accreditation system for public and private hospitals, hereby setting quality and price standards.
49
67. Finally, a strategic vision for overall human development or specific sectors i s simply missing in Lebanon. The Government i s preparing some sector strategies (for example, in education) but a broader approach needs to integrate all social aspects.
50
68. Given the above inefficiencies, inequities, misallocation of resources and the almost total absence o f a sector-wide strategy and reliable data, the justification for raising public social spending for developmental purposes appears relatively weak, at least before significant efforts are made to address the shortcomings presented above. The next section provides some recommendations that can help put Lebanon on the path to achieving better social sector outcomes. Planning for Long Term Social Development
69. Lebanon needs to define its long-term social strategy and plan for it. To create additional gains in human development, Lebanon would need to overcome a series o f constraints it currently faces. Some o f the constraints are historical (such as external regional issues or internal confessional policies) which are also partly responsible for the high private spending and the small role o f the public sector. This is in turn confounded by macroeconomic imbalances. B o t h precondition opportunities in all sectors o f the economy, including the social sectors. Thus addressing governance issues can be key for releasing and making more efficient use o f public funds and thus improving the provision and impact o f social services. Historical and macroeconomic constraints are o f course hard to overcome in a short period o f time, especially when consensual politics are required. Such reforms can be realistically expected to need a decade to implement, if not longer, which points to the urgency o f starting today.
70. But immediate actions on the social side can and should start in parallel. The first and foremost i s the development o f a comprehensive and integrated social sector strategy and specific sector strategies (health, education, social development) that are agreed upon by all stakeholders. A national commission for strategy/policy/coordination o f social policy will be needed to lead the effort.
71. From a purely public expenditure perspective, various cross-cutting reforms need to be considered. An important principle to keep in mind i s that public expenditures should focus o n key public goods domains (primary health care and education, and social protection for instance), and complement the provision o f social services supplied by the private sector, particularly given the historically large size o f the latter in Lebanon. In addition, better regulation o f the private sector i s needed (such as setting up an accreditation and quality assurance mechanism for universities) and enhanced coordination between the private and public sectors must be sought. Beyond general recommendations regarding public expenditure management or civil service reform, the following actions could be considered in the social sectorsg6: 0 Public social sector spending must be focused on poor and low-income groups and on reducing regional disparities; 0 Through changes in the public sector salary system, incentives and a level playing field in the labor market must be created by gradually shifting away from the currently “benefit There are additional areas o f government interventions that can have effects o n the social sectors but are not examined in this chapter though they should be part o f any human development strategy. Such issues range f r o m an overall assessment o f the performance o f the Government’s budget process (including specific recommendations for the budget, for example performance based budgeting) t o sectoral issues such as pensions, labor, employment, unemployment policies, c i v i l service performance and reform, water, electricity, housing, roads, infrastructure, rural development, c i v i l society/NGOs, SMEs development, informal and income generation policies including rnicrofinance, and producer subsidies. 86
51
0 0
0
based" system and towards increasing the share o f wages and decreasing the share o f benefits in total worker compensation; Targeted and means-tested programs must be introduced; Overlap between different Ministries and agencies in provision and financing o f social sector services must be reduced." Information and data systems must be developed and utilized for: (i)efficiently supporting budgetary allocations and monitoring o f public expenditures on the social sectors; (ii) identifying private expenditures by private and non-governmental providers (for cost and competitiodefficiency purposes) and also by users (household expenditures for effectiveness/equity purposes); and (iii) conducting incidence analysis (benefits o f social services).
In addition, there are measures that each sector should consider. These are briefly discussed below:
72. I n health, the government should focus i t s efforts on a few key health policy objectives: (i)enhancing the financial protection o f poor households from the costs o f ill health; (ii) improving health status outcomes particularly among the poor rural areas; and (iii) promoting greater client satisfaction with the health care system. Short to medium term measures which could help efforts towards achieving these objectives include: improving the target efficiency of M o H expenditures on catastrophic care; developing a new reference pricing model for drugs; developing National Health Accounts -- an information tool critical to making improvements in public health spending. Lastly, actions can be taken on health legislation already finalized by the Ministry o f Health and waiting for parliamentary approval. Approving the "Carte Sanitaire" legislation i s one such example and would be an important step towards the rationalization o f public and private expenditures in the health sector. Such legislation will enable the government to better track and regulate overall investments in the sector; and could improve, if implemented well, the efficiency, quality and equity o f health care services in the country. 73. I n education, the first essential step is the development o f a comprehensive sector strategy that i s agreed upon by all stakeholders." Finding ways to lower the unit cost o f public education, which i s primarily driven by the extremely l o w pupil to teacher ratios, needs to be agreed upon. This could include placing a moratorium o n teacher hiring and maintaining it until the ratio improves. A gradual phasing out o f the school grants to public sector employees needs to be implemented. Targeted instruments should be developed to reach the school-aged children who never went to school, or who have dropped out early.
74. I n social development, coverage o f the vulnerable groups needs to be enhanced through better targeting. The Social Development Centers (SDCs) under M o S A need to be reviewed, both in terms o f locations, effectiveness, and efficiency. Duplication with other Ministries needs to be reduced. Partnerships with civil society and NGOs should be better organized and standardized to improve accountability o f service providers receiving M o S A grants. 87 One example here i s the overlap between the MoSA activities in the areas o f education, training and health with those provided by the MoE and MoH. 88 Under the ongoing W o r l d Bank funded Education Development Project (EDP), the development o f such a strategy i s being undertaken.
52
The need to Strengthen Lebanon’s Safety Nets
75. Crises can irreversibly affect human capital in the absence of adequate safety nets. One basic objective of social policy i s much more humble than improving human development: it is the prevention of irreversible losses in human capital. One major effect o f crises (economic, manmade or natural disasters) i s a relatively quick deterioration o f social indicators and an aggravation o f poverty in particular (World Bank, 2001). The recent macroeconomic crises in many Asian (1997-99) and Latin American (1994-95, 1999) countries have prompted many countries to reassess the adequacy o f their social safety nets to assist poor and vulnerable population groups. Similarly, the waves o f natural disasters and the economic and social consequences that have afflicted Africa and many countries in Central America and South Asia over the past two decades also suggest the need for a more effective response to crises. A public social safety net can be an important counter-cyclical tool to help protect the incomes and human capital investments of the poor and vulnerable in times o f crisis. Effective social safety nets must be able to respond in a timely and flexible manner to changing needs without relying extensively o n administrative discretion. Setting up safety nets during a crisis i s difficult. Increasing evidence suggests that it i s better to have mechanisms in place beforehand that can be scaled up (and down) as needed. Crisis events underline the utmost need to put systems in place in advance. The 76. literature on crisiss9indeed suggests three generic lessons: 0 Social safety nets should be in place before a crisis occurs; 0 Pre-crisis planning i s essential - in the sense o f accurate and timely available information on programs, beneficiaries’ characteristics, incidence and so on; There i s a wide range o f instruments that can be used but each has different demands on administrative capacity and none can be usefully applied to all countries, all circumstances and all times.
77. Formal safety nets are generally inadequate in Lebanon. A few institutional safety nets exist in Lebanon, but none o f them could play an important counter-cyclical role in the event o f a sudden financial crisis. The end-of-service indemnity fund managed by the National Social Security Fund, which could be mobilized to cushion the impact o f massive lay-offs i s mostly invested in LBP-denominated Treasury Bills, whose value would necessarily shrink in the event o f a currency crisis. Moreover, the Government would be in an even more difficult position to reimburse the arrears i t accumulated with the NSSF. The same remark applies to the Institute o f Guarantee o f Deposits, whose funds are invested in LBP-denominated Treasury Bills. The pension schemes for military and civil servants are financed o n a pay-as-you-go basis, and have no reserves. Health care benefits covered by the M o H and the public insurance funds would also be adversely affected by a financial crisis given their heavy reliance on general revenue financing. Finally, there i s no unemployment insurance system in Lebanon. 78. Informal safety nets are strong, however they can be equally susceptible to a crisis. Lebanese families (inside and outside o f Lebanon) and communities traditionally provide ~
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For example, Sumarto et al. (2000) and APEC (2001).
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informal safety nets in Lebanon - as they did for instance during the war, but these mechanisms could prove to be inadequate (for instance, if it becomes technically more difficult to send money from abroad in the midst o f a banking crisis), or insufficient in the case o f a systemic shock. Lebanon’s wide NGO network and active civil society organizations, on the other hand, could become instrumental in the event o f a crisis, as they are probably more robust to financial or political disruption.
79.
The experiences o f other countries may be largely irrelevant for Lebanon unless the crisis i s sufficiently delayed so that formal safety mechanisms are put in place. For example, the unemployment insurance fund in Korea had sizable surpluses at the onset o f the crisis and that facilitated financing the broadening o f coverage when the East Asia financial crisis hit. The l o w initial level o f public debt in many Asian countries allowed them to expand social protection programs and spending on safety nets. Other countries, such as Peru, have created fiscal stabilization funds that can be used during crises.
80. Though one does not necessarily expect that Lebanon’s response to a crisis would be improvised and discretionary, it will take time to establish a largely coherent social safety net program. In addition, fiscal management issues and governance concerns are likely to lengthen delays in implementation. But this does not imply that Lebanon should not start strategizing for the better development as well as crisis management o f the social sectors. The authorities, governmental and non-governmental, recognize that Lebanon is in need o f a sustainable and effective safety net. If they are in place before a crisis happens, properly designed social safety nets can serve as an automatic fiscal stabilizer and contribute to greater macroeconomic stability and can bypass political pressures for panic allocation during the crisis or for making spending permanent after the crisis i s over. 81. I n designing and planning for safety nets, desirable principles to be adhered to include adequacy in terms o f coverage and benefit levels (but not resulting dependency), efficiency (well targeted with little leakages to the non-poor), efficacy (consistency to policy objectives), and transparency.’’ In this context, conventional social safety net programs that have been tried elsewhere include conditional cash and in-kind transfers, price subsidies, fee waivers for public services, feeding and nutrition programs, public works programs, micro finance programs, and social insurance programs (in particular, pensions and unemployment benefits).”
Given the above, the following safety nets can be considered in Lebanon: Protecting current social spending on education, health, and social programs: As a first principle o f financial crisis, public expenditure o n social sectors needs to be protected from budgetary cuts. Normally this entails ensuring that these expenditures do not loose value in real terms. In Lebanon, despite the fact that there are inefficiencies in all these programs (public
82.
The idea here i s that the selected measures should provide adequate protection without creating dependency among recipients (e.g. through limiting size and duration o f benefits); b e targeted, consistent with economic targets o f fiscal and macroeconomic policy. Each policy instrument has different objectives (for example, employment creation, direct relief and so on) and can use different mechanisms for targeting for example, self-targeting, means-tested targeting, categorical and geographic targeting, community-based targeting, o r proxy means testing targeting. Each needs t o be assessed separately for i t s applicability t o Lebanon.
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schools, primary health centers, SDCs), i t i s the case that the programs reach the poor since those who can afford to do so go to the private sector. Therefore, there already i s a degree o f selftargeting in who has access to public services. 83. Selectively scaling-up some of the existing public programs: Most existing social public programs are considered (or supposed to be, in the absence o f any incidence analysis) socially inefficient from a cost-effectiveness perspective. But scaling them up in the event o f a crisis could prove to be a second-best solution in the face o f the inherent large difficulties that would face any Government to quickly design and implement new safety net mechanisms during turbulent times. Specifically, while on average, the SDCs run by M o S A are inefficient there are those that are considered effective and well-targeted. A quick review o f those SDCs with a view of scaling them up if needed would be a good first step. Secondly, M o S A distributes much o f i t s funds (70 percent) through NGOs. Some o f these NGOs are known to be effective and accountable. Additional funds could be channeled through these NGOs.
84. Scale up existing social funds, reinforced with additional targeting mechanisms: Social funds are flexible financing schemes for poverty alleviation executed by local groups that promote public investments in small-scale projects in a variety o f sectors identified, and in many cases carried out, by local groups (communities, local Governments, NGOs). They have worked well primarily in pockets o f poverty in rural areas. Public works programs for the poor could be an element o f the social fund. One option would be to impose o n contractors the use o f laborintensive technologies, with a view to develop employment generation programs. Another condition would be to set l o w wages. By doing so, such programs self-target the unemployed poor.'* However, caution i s advised as international experience shows that social funds are not eminently pro-poor (pervasive leakages to the non-poor can occur), suffer from concerns about accountability and quality o f created infrastructure. The use o f social funds in Lebanon (managed by the World Bank and the European Union in particular) i s yet nascent, and could be partly amended to become more instrumental for poverty alleviation. A key element o f scaling up the existing social funds in Lebanon would be to bundle the existing ones into one single autonomous social fund. 85. Introducing conditional cash transfers: Conditional cash transfers are public programs that provide cash to the needy in exchange for verifiable changes in behavior. Often they are tied to children's school attendance or vaccinations, or can be conditional on work search or training. Conditional cash transfers have been shown to reach the poor and are particularly effective when school and health facilities already exist but poor children do not attend and do not receive vaccinations regularly. This i s applicable in the case o f Lebanon where supply o f facilities is not the constraint nor expected to be in the event o f a crisis. Conditional cash transfers would help sustain demand for the basic services if implemented properly. Another type o f conditional cash transfer that can be considered in Lebanon i s a "social pension", i.e. a flat rate pension targeted to those above a certain age and not in receipt o f a pension. L o w levels o f each type o f benefits would ensure self-targeting. 92 I t i s often argued that such programs w o u l d prove t o be unsuccessful in the presence o f a low-skilled immigrant labor (which would be the m a i n beneficiary). This problem could nevertheless b e overcome by verifying the nationality o f candidates. And as this type o f program ensures efficient self-targeting and entails modest fixed costs, it i s not too costly to test and expand in case o f success.
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Waiving hospital co-payment fees for the poor. While the poor can be admitted into 86. public hospitals in Lebanon, they nevertheless have to pay a 15 percent co-payment, which can be a significant amount for the poor and especially in times o f economic hardships. One option to consider i s waiving the co-payments or at least reducing i t significantly.
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Chapter IV. Building Capacity for Better Provision of Public Goods
87.
Tackling governance issues i s critical to support the fiscal adjustment. As underlined
in Chapter I,the fiscal adjustment would be supported much more broadly if i t were perceived
primarily as aimed at improving governance. If seen as a means to permanently reduce waste, inefficiency and corruption, i t will be supported politically over time. By the same token, it will also reinforce the credibility o f the Government’s plans vis-&vis i t s financiers, financial markets and the donor community, hence possibly mitigating borrowing costs and financing i t r s implementation. The Current Situation
88. Lebanon’s overall governance quality i s well below what would be expected given its level of income, and moreover, i s deteriorating over time. As evidenced by Figure 6, despite faring better than most countries in terms of voice and accountability, in most other important areas relevant to governance, including political stability, government effectiveness, regulatory quality, rule o f law, and control o f corruption, Lebanon i s doing worse than average for the MENA region. Time series comparison over the period 1996-2004 reveals that Lebanon i s also faring comparatively worse today than i t was in 1996 on virtually all governance indicators (see Figure 7). These are troubling findings, given the fact that Lebanon in 1996 had just got out o f a civil war, and the physical infrastructure o f its public administration had been completely destroyed and thus i t s ability to provide services to the citizen was seriously hampered. Lebanon appears to fall short of other countries at similar income levels in the 89. indicators specifically measuring the quality of public administration. This highlights the presence o f bureaucratic corruption, points to a weakness in the enforcement o f rules and regulations and identifies shortcomings regarding the quality o f the budgetary processes, public management and the efficiency o f revenue mobilization. This evaluation i s consistent with country specific assessments on Lebanon’s public administration. The i l l s o f the public administration have been thoroughly evaluated and analyzed over time and there i s a strong domestic consensus over the deficiencies highlighted above: today, the Lebanese public widely views the public administration as being wasteful, corrupt and inefficient and totally unresponsive to the needs o f i t s citizens.
90. Corruption i s endemic and costly. In 2004, Transparency International’s corruption perception index ranked Lebanon 97th out o f 133 countries. In the region, it i s tied with Algeria in terms o f perception of corruption; only Yemen and Iraq score lower among Arab countries. In terms o f corruption in public administration, Lebanon i s below the median worldwide, with worse scores than most of the countries in the MENA region according to the World Bank (World Bank 2003a), and the World Economic Forum (World Economic Forum, 2002). The cost o f weak governance in MENA amounts to over one percent point o f missed growth per annum (World Bank, 2003a). Transaction costs for starting a business are among the highest in the world, amounting to almost 130 percent o f GNI per capita (World Bank, 2005d), contract enforcement is slow and costly because established property are not effectively respected and enforced through the judiciary. Moreover, i t takes more than two years to recover private debt in
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Voice
d i d liCCOU0
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underreport the activities o f the public sector. The official government budget, prepared by M o F and approved by Parliament only covers central government spending as executed by 29 firstline entities and 76 second-line entities. Foreign Financed Investments (FFI) under the purview of the C D R and a number o f other public autonomous entities operate outside o f the regular budget. These include ElCctricitC du Liban (EdL), the National Social Security Fund, Banque du Liban (BdL), the National Archives Agency, four consolidated water authorities, public hospitals, and over 60 other entities. While not part o f core activities o f the Government, their activities have important fiscal implications. Very often, the absence o f any binding budget constraint (governance problems, lack o f accountability and accounts) prompts these entities to run arrears and losses, which are eventually covered by the Government in the form o f grants or loans. 93. Ministerial scrutiny over budget submission i s lacking. Currently, the development o f budget requirements within ministries is not the reflection o f well-developed priorities within a sector, Instead, within ministries, the accounting staff simply rolls up the individual, unconstrained, budget submissions from all o f i t s budget entities. This aggregated budget i s presented to the minister, who signs i t for transmission to MoF. This mechanistic approach to developing budget submission i s not consistent with an environment where financial resources are scarce and need to carefully be monitored to improve their impact.
94, There i s no link between the capital budget of the Government and its operating budget. Thus a completed capital project will not automatically generate an approved future stream o f operation and maintenance expenses required to maintain the capital project during i t s lifetime. The very tangible effect o f this situation i s that Lebanon’s physical infrastructure i s eroding and this affects the quality o f public services. During the past ten years, Lebanon’s public administration infiastructure has been largely rebuilt. The process o f reconstruction which directed billions o f dollars into the economy, created a functional infrastructure for the majority o f services. However, funds for operation and maintenance o f this equipment are scarce. As a result, much o f the information technology equipment that has been acquired has become obsolete, and many o f the capital expenditures that have been made are beginning to seriously erode. This affects the ability o f the administration to provide adequate services. 95. The Lebanese budget system i s very rigid and cumbersome. It i s entrenched in a legalistic tradition which encourages redundant and time consuming ex ante controls, thus hampering the ability o f spending ministries to deliver services in a timely fashion. An internal ex-ante control exercised by M o F employees located in the line ministries focuses on legal compliance with the Parliament’s appropriation and all other applicable legislation affecting the particular transaction. The controllers in this case perform no verification for the timing o f cash flows, thus line ministries can presently commit their entire appropriation at any time o f the year, with no regard for whether M o F i s able to finance it. This contravenes best international practice, which encourages ex-ante controls to be exercised by the concerned line ministry financial officer. In addition, a Court o f Account Ex-Ante control is performed for those commitments that exceed certain thresholds. The Court o f Accounts has 10 days to review the request and make i t s recommendation. This i s passed back to the controller, who then sends the approved request to the ministry’s accounting unit for onward processing. Refused requests are returned to the originating unit. The Court o f Accounts intervention in ex-ante verification o f transactions
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contravenes best international practice as i t puts the Court o f Accounts in a potential conflict when i t performs its ex-post verification o f the transaction.
96.
The public labor force i s unqualified, lacks motivation, and i s oblivious to citizen’s needs o r demands, responding instead to sectarian political considerations. The public administration has effectively become an expanded social safety net in the post-war period with considerable overstaffing. This dilutes the accountability and productivity of the public sector and affects the delivery of services to the citizen. The most reliable estimates put active public sector employees at about 220,000 people.94 They are distributed as follows: (i) military and 42,000 teachers; (iii) some 33,000 employees in public security personnel o f about 95,000; (ii) autonomous agencies and state-owned enterprises; (iv) about 15,000 people in the general administration which are regular civil servants, out o f 25,000 positions in the organizational structure; (v) additional 13,000 are contractual and daily workers in the civil service; and, (vi) approximately 12,000 people are employed by the municipalities. Most o f the government employees are considered unmotivated, underpaid and not expected to produce quality services beyond the bare minimum. O n the whole, given the large numbers o f people who are not actually providing any value added within the ranks o f Government, it i s safe to say, that the Government in Lebanon i s severely overstaffed for the functions it currently performs. The relative age o f the workforce (see Chapter 11) further reduces the means to motivate the workforce beyond the purely monetary incentives.
97. Public administration i s largely dysfunctional due to existence o f dual structures. After deciding o n a hiring freeze in the civil services, the Government relied o n contractual workers to ensure the functioning o f the state departments and ministries. Contractual workers receive higher wages than regular civil servants, and they are not bound by civil service regulations on issues related to hiring, evaluations, and promotions. This de facto creates a dual structure o f employment and has been the main cause for dysfunction. In addition to this dual employment structures, a number o f consultants (mainly financed by UN agencies and other donors) are largely involved in the day-to-day operations o f ministries and the conduct o f strategic work o f ministries. This creates a dichotomy within the ministries, where there are staff sometimes performing similar tasks while earning very drastically different salaries, and definitely creates tensions and resentments within the public sector, which also have very negative effects on the performance o f public administration and i t s staff. This also complicates the reporting system and dilutes accountability, and hampers the delivery o f effective services.
98. While the educational attainment within the civil service i s quite good, employees are poorly trained. Only very few staff within the civil service are considered illiterate, with a large proportion holding bachelors degree or above. However, the years o f the war reduced markedly the qualified manpower in the post-war era and very little has been invested in ensuring that civil servants are trained. Training provided by the C i v i l Service Council was limited. In 2003, the Government has formed the Ecole Nationale d’Administration du Liban (twinned with ENA in France) to improve the level o f training for civil servants. Training i s today one o f the most pressing and important challenges facing public administration.
94 Source: S t a f f s interview with Yahia Hakim, December 2003. Some reports, like Salem (2003) put the total number o f public employees in Lebanon at 260,000.
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99. Public servants’ wages are largely inadequate and provide a poor motivation and incentive framework. As already mentioned in Chapters I1 and 111, while spending o n wages, salaries and associated benefits represent the second largest component o f fiscal spending after interest payments, the wage represents a disincentive to efficient working conditions. In addition, the working hours for public administration are very short compared with other countries and with the private sector. Currently, public administration works a total o f only 32 hours a week spread over 6 days.
The Reform Agenda
100. A comprehensive public sector reform agenda should simultaneously cover four fronts: public administration, public financial management, civil service and corruption. In the Lebanese context, addressing deficiencies in these four domains could go a long way in improving the credibility o f the institutions vis-a-vis the population and the donors, and contribute positively to a successful fiscal adjustment. By contrast, fragmented piecemeal efforts to address one o f these issues are unlikely to succeed without simultaneously addressing the others. Current efforts to improve the c i v i l service are being fought o n the margins. They focus o n marginal measures to combating corruption, improving the climate for private sector development and strengthening the regulatory powers o f the public sector. While these efforts are good in their own right, they m a y not succeed without concurrently re-defining the role o f the State and improving financial, expenditure and human resources management. The key priorities in public sector reforms should be (i) the definition o f the environment and the needs o f the public sector; (ii)the development o f a longer term human resource management policy (addressing the issues o f size, recruitment, wages, training, etc.); and (iii) the modification o f the administrative culture, focusing o n customer relation and service, and emphasizing streamlined procedures, delegating authority to the lowest level o f competence; and deepening reforms in the clusters o f excellence, and (iv) the reduction o f corruption. Public Administration
101. The Reform Strategy should focus on narrowing the scope of Public Sector intervention: doing less but doing it better. The public sector in Lebanon intervenes in many domains, but remains weak in those sectors where the private sector cannot participate: core state responsibilities (such as fiscal and economic policy, foreign affairs, order, justice, external security and relations with other layers o f Government), the regulation o f social sectors (education, HR, culture, welfare and social policy), the management o f economic resources (which generally includes industrial and trade policy, natural resources and infrastructures) and the correction o f market imperfections (monopolies, externalities, asymmetry o f information, etc.). Within each country, given its social, political and economic context the exact function o f any given ministry varies. While overlapping o f institutional responsibilities i s certainly not specific to Lebanon, an obvious characteristic o f the Lebanese institutional structure is the high number o f ministers and ministries as can be seen in Annex 2. While these may reflect the realities o f the political system in Lebanon, it i s worth noting that there i s a tradeoff to b e made between institutional efficiency and representation.
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102. Concentrating government resources in core activities and institutions i s costeffective. International evidence in public management suggests that reducing the number o f institutions tends to increase the flexibility o f government action, improve efficiency and eventually- reduce costs, by cutting back bloated and inefficient public agencies and moving towards greater marketization o f the economy. International experience also suggests that streamlining portfolio positions improves coordination and execution o f policy and that by grouping functions into homogeneous units it i s possible to facilitate the exercise o f distinctive authority by ministers, without risks o f overlap or gaps, and thus foster accountability. Making cabinet decisions will be easier with a fewer number o f ministers at the table each vying to push their agenda, a practice that almost always dilutes the decision-making process for large collegial Governments. Fewer ministries are also likely to greatly simplify the budget process, increasing transparency and efficiency o f resources more directly to outcomes and away from operation and maintenance. Finally, a reduction in the number o f ministries i s likely to forcefully reinforce the message that the State will restrict its actions to that o f a regulator and refrain from activities in which the private sector can legitimately perform at least similarly. 103. Decision making in the Lebanese public sector i s highly centralized. This creates a culture o f centralization and refusal o f responsibility that only hampers the civil service by creating additional delays. Lower levels o f the executive authority could more effectively undertake many decision^.'^ Delegation o f task at the lowest level o f competence does not require important legislative framework as the law already provides for this. I t s actual implementation will greatly improve the efficiency o f the public service, provided i t i s monitored. Finally, strengthening municipalities to enable them to undertake the tasks, which are constitutionally allocated to it, i s an important step to improve public service delivery. Subsequently, focusing on decentralization, and encouraging additional devolution o f tasks to lower levels o f Government shouldcould be envisaged.
104. Reducing government intervention by simplifying bureaucratic procedures. Most government services are exceedingly cumbersome. They require a large number o f signatures, visits and expenses on the part o f the citizens. L a w does not mandate most o f these bureaucratic steps, rather by customs and use. Reviewing these activities, with the aim o f reducing the time and money necessary to conduct these operations, will be cost-effective and will have a positive impact on the citizens. There are very successful examples in Lebanon where simplification o f procedures has reduced time and cost and improved service delivery. For example, passports can now be applied for and delivered by post. The land cadastre, cited before, is another successful example.
For example, the Council o f Ministers often decides o n the move o f a janitor from one school to another or the approval o f training courses for civil servants.
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Public Financial Management
105. Building a Medium Term Expenditure Framework (MTEF) to improve the allocation of public money and its effectiveness should be considered a priority. This will allow the unification of capital and current expenditure budgets, thus allocating appropriate resources for both the construction and maintenance o f public infrastructure and will assist moving towards program budgeting. This will focus the budget process in the evaluation o f outcomes, and create a systemic incentive for improved services. I t will allow for the streamlining o f the expenditure circuit and the reduction o f many o f the crippling ex-ante controls which make the system cumbersome and legalistic. Furthermore, i t will entrench moving towards accrual budgeting which has n o w become the international standard. Finally, it will enable the integration of simplified and computerized applications into a single GFMIS improving transparency and speeding up reporting. This is a long and complex l i s t o f activities given the limited implementation capacity which exists o n the ground. Accordingly i t s implementation will require the sequential execution o f the different necessary actions and a strong emphasis on management of the reform process. Within this process, tackling the 64
achievement o f Performance / Program budgeting should come first given its potential impact in transforming the incentive system in the l i s t o f priorities, with a view to trigger a shift in public sector mentalities (away from political considerations; and towards resources allocation corresponding to needs).
106. The MTEF i s the key feature of a modern performance-related budget system as i t recognizes the importance o f fiscal sustainability / discipline as a necessary condition to meet any other government objective. I t i s an instrument to reconcile medium term macro and sectoral objectives. In Lebanon, the need for political balance in public expenditure allocation and the absence o f consolidation between current and capital budgets makes the move to an MTEF difficult. I t also requires a change in the nature and amount o f accountability/responsibility o f public officials, towards fewer ex ante controls in exchange o f more accountability for results. Options for an MTEF combine various dimensions, including the level o f sectors desegregation, the participation o f non-governmental bodies (Parliament, civil society, donors) in the setting o f priorities, and the extent to which the MTEF becomes an instrument for competitive resource allocation. What i s not an option but a must i s the need to develop fonvard-looking macro frameworks and outcome-based sectoral strategies. 107. The development of the MTEF system requires upfront planning and political decisions to be made to ensure the appropriate design. Various resource allocation mechanisms can be envisaged, once the macro-envelope is decided: (i)envelope per ministry/sector decided upfront, (ii) competition between ministry/sector until the last minute, (iii) proportional allocation. The MTEF can also be confined to fixing a macro-envelope and putting the budget decisions in a fonvard-looking perspective (as multi-year budgeting does not exist anywhere). Options for program budgeting include the program structure (Le,, the definition o f sectors objectives, functions, activities; at the ministerial, sub ministerial or intraministerial level), the specification o f performance indicators (a small number o f relevant outputs to be preferred to outcomes, as measurable and assignable; costing possible without accrual accounting) and the various aspects o f performance management. Finally, the reasons for program budgeting need to be spelled out, to gain support within the administration: individuals incentives; allocating resources based on past and/or expected performance; enhanced information on budget achievements. 108. Improvements in budget fundamentals will have to be conducted in parallel. Accordingly, work can start in earnest. There i s no need to have an accrual accounting and integrated management system before starting to move on improving budget fundamentals. Among them: 109. Current and capital budgets must be unified. After ten years o f activity, CDR role should be revisited to fit the changing times. I t s role could be redefined to become an implementation agency o f Ministries, which could regain control on their investment budget. Accordingly, closely integrating current and capital budgets, consistently with best international practice could (i) improve aggregate control o f budget expenditures and priorities, (ii) link the future budgetary expenditure implications o f the investment budget, and (iii) improve the flow o f
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information between the MoF and CDR during the separate budget formulation processes. In this respect, the possibility of carry-forwards should be limited in the budget framework.
110. The draft Public Procurement Law prepared by the Government should be approved and implemented. Such a law would not greatly enhance the efficiency and transparency o f public procurement procedures, but it would also accelerate disbursement on donors’ projects. Recent steps taken by the Government to reform procurement practices regarding drugs and fuel purchasing illustrates the extent to which savings can be made by reinforcing competition among suppliers. The adoption o f a competition law would definitely help in generalizing these efforts to most Government’s purchases. 111. The Public Accounting Law should be reviewed. The revision o f the now outdated Public Accounting L a w and the development o f ex-post performance evaluation would mitigate corruption risks stemming from a lengthy, complex and non-transparent expenditure control process, with a view to shift public practices from compliance to responsibility. Granting greater institutional independence to the Court o f Accounts vis-a-vis the Government and reinforcing i t s capacities would also be a crucial step in this direction. 112. Extra-budgetary entities’ activities need to be audited and consolidated into the budget, As posing a significant risk o f seeing public funds not being spent for the purposes for the Government dispose rapidly which they have been appropriated, it i s hence important that (i) o f a set o f audited consolidated financial statements that cover all non-budgetary entities; and (ii) that public autonomous agencies and funds’ budgets be fully consolidated into the budget o f the Government and their accounting, reporting, oversight and governance structures be significantly be improved. 113. Hard budget ceilings need to be imposed on ministries. W h i l e an MTEF i s very important, for i t to be effective decision processes at the center o f the Government have to be reformed. This includes early government decisions on priorities and (in the current situation) policy decisions o n cost savings and service reductions which are communicated to ministries for their budget formulation process. I t implies the use o f hard budget ceilings for formulation o f the budgets and reforms of the budget process within ministries, to move away from simply summing up the cost o f inputs.
114. The Government should immediately stop relying on accumulating arrears, Although not yet audited and tentative (in the absence o f accrual accounting), the amount o f arrears accumulated as o f end-2004 by the Government vis-a-vis the social security, government employees, suppliers and households i s seemingly sizeable, at approximately 14 percent o f GDP (see Chapter 11). Building-up arrears has various negative consequences: poorer fiscal transparency, higher tariffs for private services, weaker social safety nets, and greater difficulties to implement investment projects. In this respect, not accumulating new arrears i s a first immediate priority, which will nevertheless add about one percentage point o f GDP to primary spending (as measured on cash basis).
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Civil Service
115. Unless the issues of recruitment, retrenchment and wages are addressed, the public sector will remain inefficient, costly and prone to corruption. A new and aggressive Human Resource strategy, which focuses on recruitment o f qualified staff and identification o f performing staff is needed to introduce new blood into the system. Human resources management reforms have to be conducted in accordance with changes in management practices and introduction o f performance management and monitoring into the civil service. A better paid, more competent, smaller public force should be the objective. Note that given the public service’s relative age, the Government need not conduct an aggressive retrenchment o f i t s public workforce (see Chapter 11). Reduction o f redundant employees can be achieved through attrition. Creating a new salary structure which i s in par with private sector levels, and developing an appropriate recruitment strategy which i s transparent and rewards merit and qualification foremost are also a must. In the short run, this will necessitate (i) a review o f employment needs a civil service census, and (iii) a termination o f the and adequacy to government’s objectives, (ii) current hiring and wage freeze in place since 1997. With a view to re-build capacity within the administration to ensure continuity and accountability, the reliance on parallel staffing structures should also be reduced as much as possible. 116. Public labor force non-wage benefits should be replaced with higher wages. Obviously, the reform o f public pension schemes which should accompany the reduction o f the public labor force through attrition (see Chapter 11) would eventually necessitate reducing the benefits accruing to current and new retirees. On the same token, benefits (family allowances, education, and health) to public sector employees should be reviewed in light o f actual social needs, and probably replaced with more direct and effective means o f channeling assistance to the poor. This decline in non-wage benefits would typically be offset with higher wages in the public sector. N o t only would this permit to reinforce social protection policies effectiveness, but would also establish a better link between individual performance and remuneration in the public sector. 117. Strengthening the central oversight bodies such as the Civil Service Council, the Central Inspection Commission, Central Audit are essential aspects of the public sector reform agenda. These agencies are now highly sclerotic and need to reorient their activity along modem concepts o f human resources management, and concentrate on developing a vision for the civil service o f tomorrow and i t s functions. 118. Few institutions have made great strides in terms of administrative reform. The Ministries o f Finance (MoF) and Economy and Trade constitute a core o f excellence within the public administration. Their reform processes have started with the assistance o f donors. The new VAT i s being managed with new employees who received intensive training and better incentives. Similarly, the automation o f the custom administration and the change o f i t s business procedures led to remarkable achievements in terms o f productivity and better results. Deepening these reforms would be to focus on systematizing the training functions, especially for existing employees, as well as focusing on the development o f these administrations in areas away from Beirut. In addition, OMSAR needs to be empowered to promote change and i t s role needs to be further clarified.
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119. There i s a need to focus on processes first and technology second. Ironically, Egovernment is one o f the rare agenda items that all parties espouse and encourage. While i t s merits, in terms o f increasing transparency, are significant and they have a real impact in reducing corruption by eliminating the human middleman, i t s efficiency depends o n making sure that the sequence o f actions i s correct. This sequence i s to focus on the simplification o f processes first and computerizing the procedure second. In Lebanon, enormous attention i s dedicated to the development o f the technical solution, but not as much o n the simplification o f processes. This could systematize inefficient processes that encourage corruption rather than reduce it. Corruption 120. Any credible attempt at Public Sector Reform will have to address corruption frontally and in a sustainable fashion. N o credible fiscal and governance reform can be forged without addressing the issue o f corruption frontally. As has been mentioned throughout this chapter, patronage and sectarianism have created significant distortions in the public sector, and among them significant corruption. Corruption i s often associated with public procurement. A UN assessment conducted in 2003 mentions that that over 43 percent o f companies in Lebanon "always or very frequently" pay bribes and another 40 percent "sometimes" do. 121. Launching an anticorruption program does not require dramatic initial steps beyond a credible leadership and finding an appropriate entry point for anticorruption work. Small gains can provide useful levers to sway public and official opinion. Entry points should be chosen to tackle high profile problems that respond to public opinion or business dissatisfaction. The Government o f Lebanon has indicated that it is planning to create the position o f Ombudsman as a mean to address corruption. This could be an important step, provided the Ombudsman i s able to perform its duties unfettered by the usual considerations which hamper the functioning o f the Government in general. 122. Nevertheless, proper sequencing should be designed to enhance the credibility of leadership and to ensure early tangible results to strengthen the constituency for reform along the way. First, it requires a critical mass o f mutually reinforcing reforms that ultimately builds into a comprehensive program. Isolated islands o f integrity can provide an entry point and a valuable demonstration effect but may only survive a short time before being swamped by corruption at other levels. In order to be mutually reinforcing, the strategy must also be balanced. This suggests a m i x o f corruption-prevention and enforcement measures combined with substantial public involvement and education to strengthen the constituencies for reform. 123. Sustainability requires the eventual development of a broad coalition in support of the strategy. Though gaining entry to anticorruption work might require an initially narrow approach, any strategy that relies only on high-level leadership will be vulnerable to the many uncertainties o f the political process. The strategic commitment to gain entry must be broadened to incorporate key state institutions and organizations within the c i v i l society. Small- and medium-sized enterprises, professional societies, trade associations, and labor unions can all serve as important partners in an anticorruption strategy. The development o f a broad coalition
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will reduce the vulnerability o f anticorruption strategies to leadership changes and ensure that politicians ignore the corruption issues at their peril. Where c i v i l society remains severely repressed or is emerging only slowly, a combination o f fear and/or lack o f familiarity with civic involvement m a y inhibit popular participation in an anticorruption strategy. The strategy will need to include a component that can accelerate i t s emergence by canvassing client groups, promoting collective action, giving voice to the poor, and setting up monitoring o f government services at both national and sub-national levels. External donors can play a role in funding and supporting mechanisms of voice but should ensure that they do not dominate or pre-empt the development o f authentic and autonomous participation, sustainably based in the community. 124. Systainability requires the resources and expertise to see often complicated reforms through to completion over the long haul as well as deliver the credible early results noted above. This implies a m i x o f short-term measures and adequately funded medium-term programs that can dig deeper into the underlying causes o f corruption and build institutions that can resist it. Well-intentioned reforms that are not realistically backed with sufficient resources and expertise will backfire. Governments must assign budget resources as well as competent administrators to these programs. C i v i l society can only do so much o n i t s own. Business associations and NGOs can help identify priorities and can monitor results, but they cannot deploy the political will and resources o f the State that ultimately are needed to reform the State and create the framework for transparent and competitive markets.
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Annex 1. Developments in Public Finance, 1991-2004 Overview 125. High fiscal deficits characterized Lebanon throughout the post-war period. Both high spending levels and lower revenue mobilization efforts were behind the high fiscal deficit. Heavy borrowing in the 1990s and the mounting debt burden have become the main factor behind the high and rising fiscal deficits. Payments arrears surfaced regularly since 1996. A first massive payment o f arrears occurred in 1999, but arrears had built up again since and amounted to 10 percent o f GDP by end-2004. As a result, the consolidated public debt over GDP could have reached 175 percent o f GDP by end-2004. 126. A turn around in primary fiscal balance occurred since 1997 with major cut in fiscal deficits. Fiscal revenues increased by more than 7 percentage points o f GDP since 1997. Major efforts to increase tax revenues improved revenue mobilization despite reduction in customs revenues as a result o f reduction in import tariffs. The most impressive effort have been the introduction o f the value-added tax (VAT) in 2002, taxes on interest income from deposits in 2003 and continuous improvement in tax administration. On the expenditure side, the bulk o f adjustment took place at the expense o f capital spending. Since 1997, the primary balance gained 12 percentage points o f GDP. At the same time though, debt service continued to grow, the result o f growing debt, somewhat offsetting gains achieved on the primary balance. Only in 2004, when the impact o f debt restructuring efforts from donors and commercial banks undertaken in 2003 was felt, did the debt service started to decline. See Table 13. Quality o f Fiscal Data 127. Lebanon’s budget system does not comply with the principle of unity. The Central Government has dual budget: (i) the general budget approved by the Parliament and (ii)the Budget o f the Council for Reconstruction and Development (CDR) approved by the Cabinet. The G o L differentiates between domestic and foreign financing capital expenditure, with the latter excluded from the budget balance. The CDR, an off-budget institution, carries out the bulk o f capital expenditure. This system complicates the process o f maintaining aggregate control on fiscal spending, which creates difficulties in linking current and capital spending and fragments sector priorities. The data given in this chapter includes both the foreign-financed investments and the investment financed by the government budget (see Chapter I and I1 for comprehensiveness o f budget). 128. The quality of fiscal data i s relatively poor, despite recent progress in improving coverage and frequency o f data. The coverage o f fiscal statistics is incomplete and i t s full details are not available on a timely basis. The o f f budget expenditures are all regrouped under the item Treasury expenditures, which includes transfers to the power company, municipalities, expenditures on previous exercises and a multitude o f other expenditures. The administrative classification o f expenditures i s available since 1993, but i s not comprehensive. The available economic and functional classifications only date back to 1997. A summarized economic classification i s available for earlier years. Most o f budget data published are on cash basis.
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Public Expenditure Structure and Evolution 129. Dominated by interest payment and wages and salaries, current fiscal spending represented 85 percent of total fiscal spending during the period 1991-2004 in Lebanon. During the same period, more than three quarters o f this spending can be classified as inflexible because o f allocations to only wages and salaries and interest payments. The combined share o f wages and salaries and interest payments reached as high as 80 percent o f total current spending in the last four fiscal years. In particular, interest payments increased from about 4.7 percent o f GDP in 1991 to a peak o f 16.9 percent o f GDP in 2001. Allocations for wages, salaries and associated benefits (pensions, indemnities and end o f service benefits) remained fairly stable and increased from 8.5 percent o f GDP in 1991 to 10.5 percent o f GDP in the last four fiscal years. See Table 14. 130. All other components of current spending (excluding interest payments and wages and salaries) represented only 22 percent of current spending during the period 1991-2004. This share declined to about a fifth o f total current spending in the last four fiscal years. Within that category o f spending, transfers have been the major item. Transfers to EdL and other extrabudgetary agencies averaged 2 percent o f GDP during 1991-2004. Subsidies for sugar and beat were eliminated and the G o L introduced targeted subsidies for transportation and lower interest rates for SMEs. Allocations for goods and services were meager and have been around 0.8 percent o f GDP during the same period (compared to an average o f 6.5 percent o f GDP in other Middle-Income Countries). Other Treasury outflows increased in the last five years and they averaged LBP800 billion during 1999-2004. I t should be noted that payment arrears in both current and capital spending started since 1997 and continued over the period until 2004 with the persistence o f substantial year to year carry over. 131. The bulk o f expenditure containment that took place between 1997 and 2004 resulted from a major cut in domestically financed capital and investment spending. Total capital spending increased steadily after the end o f the civil war, averaging 8.5 percent o f GDP between 1994 and 1997. Since then it continued to decline steadily and it represented 2.9 percent o f GDP in the last four years. The additional capital spending financed outside the budget by donors directly through the Council for Reconstruction and Development (CDR) represented 27 percent o f the total since 1993. 132. The structure of the functional classification of the budget i s consistent with the economic classification. Available since 1997, the structure constantly shows the public debt transactions as the largest share o f the expenditures with 41 percent o f total expenditures between 1997 and 2004. Over the same period, the defense and security, education, health and social affairs, all function with a high level o f employment absorbed 39 percent o f expenditures. See Table 14. 133. The military and security expenditures capture a substantial share of the budget. Military expenditures increased by 6 percent a year on average since 1995. The increase in the years following the end o f the war was more intensive. As a part o f the peace-building efforts, several members o f the militias were incorporated into the military and the security services and
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the army almost doubled their staff since the end o f the war. Military and security expenditures (including pensions) peaked at 8.2 percent o f GDP in 2001 and represented 41 percent o f primary spending between 1997 and 2004. 134. Social expenditures increased rapidly during the past ten years. Between 1994 and 2004, expenditures on education increased by 9 percent on average each year, and rose as a share o f GDP from 2.1 percent in 1994 to an average o f 2.6 percent since 1998. The health sector also benefited from substantial increases with an average annual growth rate o f 10 percent between 1994 and 2004. The ratio o f health expenditures to GDP rose from 0.8 percent in 1994 to more than 1 percent in 2000-2004. Public Revenue Structure and Evolution 135. Fiscal revenues increased by an annual average growth rate o f 21 percent during the period 1991-2004. The G o L revenue base was considerably weak at the end o f the war in 1990, and should not have exceeded 5 percent of GDP. Fiscal revenues rapidly increased to 15 percent o f GDP at the end of the year 1991, as fiscal administration started operating normally. The 1992 devaluation had a severe impact on fiscal revenues and brought them down to 13 percent o f GDP. Then, with the recovery o f the economic activity, fiscal revenues rose slightly to 13.3 percent o f GDP in 1994. The revenue to GDP ratio then increased to 19.5 percent in 1999 triggered by both the increase in tax rates and the improvement in tax administration. At end 2004, the revenues to GDP ratio reached up to 23 percent due to the introduction o f the VAT and the tax on the interest revenues o f deposits. See Table 15. 136. Taxes on international trade (customs and excise) have been the major source o f tax revenues in Lebanon over the period 1991-2004. They increased from 5.4 percent o f GDP in 1993 to 7.8 percent of GDP in 1999. A targeted reduction in import duties was implemented in late 2000. Some custom fees have also been reclassified and considered as consumption tariffs. A number o f goods were also exempted from custom duties in 2003 (mainly industrial raw material) and a number of bilateral and regional agreements with Arab countries led to reduction in custom revenues. Consequently, customs revenues declined to 4.9 percent o f GDP in 2004. 137. Taxes on income and profit increased, although from a small base. They represented only 1.3 percent o f GDP in 1993, declined to 1 percent o f GDP in 1995 following the reduction o f tax rates and increased steadily since 1996, reaching 2.8 percent o f GDP in 2004. As a result o f adoption o f the tax regularization law in 2001 and the tax audit o f large taxpayers in 2001, taxes on income and profits increased rapidly in the last three years. In 2003, a 5 percent tax on interest on bank deposits was also adopted yielding 0.7 percent o f GDP in 2004. Conversely, taxes on property, mainly registration fees, went back in 2004 to their 1993 level, 1.2 percent o f GDP, after peaking at 1.7 percent in 1999. 138. A Value-Added Tax was introduced in February 2002. A VAT (at a rate o f 10 percent on goods and services, with few exemptions) was introduced in February 2002, adding about 5 percentage points o f GDP to tax revenues by end 2004. This raised the share o f taxes on goods and services from only 1.3 percent o f GDP in 2001 to 6.5 percent in 2004. Revenues from VAT are expected to stabilize from 2005 onwards as the consequences o f the improvements in
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collection and the reduction o f the threshold for businesses to LBP15O m i l l i o n were already effective in 2004. Gasoline tax was raised during 2001-2002, but was again reduced and the price o f gasoline ceiled in 2004. The petroleum tax then decreased by LBP175 billion (0.5 percent o f GDP) between 2003 and 2004.
139. Non-tax revenues remain weak in Lebanon. During 1993-1997, non-taxes revenues in Lebanon varied between 1 and 2 percent o f GDP in comparison with 14 percent in other MiddleIncome Countries. Despite increases in subsequent years (5.8 percent o f GDP at end 2004) they remain weak. Revenues from the Telecom sector (cellular and fixed lines) are by far the largest sources o f non-tax revenues (4 percent o f GDP in 2004). They are followed by the administrative fees, charges, fines and forfeits as well as smaller revenues from the Central Bank (BdL). The importance o f grants declined from the high levels witnessed in the mid-1990s and other Treasury revenues declined from 2.2 percent of GDP in 2000 to 1.3 percent in 2004.
73
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